An emergency fund is a crucial component of any sound personal financial plan. The fund acts as a financial reserve or safety net, to cover unexpected expenses, or interruptions in income without disrupting your long-term investments, which potentially could cause financial loss or adverse income tax consequences.
The first step in the creation of an emergency reserve fund is to determine your basic needs or living expenses. Often this amount is referred to as the monthly ‘have to’s’. Expenses include items such as food, health insurance premiums, mortgage payment or rent, and utilities. Do not include discretionary spending or income taxes. The second step is to determine how many months of emergency reserves are required based on your specific facts and circumstances (see below).
Example, if you need $4,000 per month, and the number of months required is three, then your emergency fund should be $12,000 ($4,000 X 3).
An emergency reserve fund should be held in a deposit account, or a cash equivalent account such as treasury bills or a money market mutual fund. The priority should be for liquidity over potentially higher returns. As noted, the recommended amount, stated in the number of months, for an emergency fund varies based on individual facts and circumstances such as health considerations, dependents, sources of income, and type of employment.
A reserve of three months is recommended when there is any of the following:
- Access to credit facilities such as:
- An investment credit line
- Life insurance guaranteed cash values
- High employability
- Households with at least two sources of income, and not from the same employer
A reserve of six months is recommended when there is any of the following:
- Children or other dependents
- Employment with high turnover or seasonal layoffs
- Households with a single source of income
A reserve of 12 – 18 months is recommended when there is any of the following:
- Chronic health conditions
- Concentrated stock positions
- Illiquid assets
- Retirees
Personal Financial Planning Considerations:
- Determine the number of months of emergency reserves that are required based on your unique facts and circumstances.
- Identify your monthly living expenses
- Begin saving – slow and steady wins the race. A good goal is to fully fund your emergency reserves within 36 months
Tax laws directly impact an individual’s personal financial plan. At Paraklete® Financial we work with CPA’s as part of our client’s collaborative team of advisers. The collaborative team is essential to the personal financial planning process. For more information, please visit us at https://www.parakletefinancial.com
The views expressed are those of the author as of the date noted, are subject to change based on market and other various conditions. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Keep in mind that current and historical facts may not be indicative of future results. The information contained in our presentations have been compiled from third party sources and is believed to be reliable; however, accuracy is not guaranteed.
