Last week, we began a discussion on the importance of establishing a personal savings account. This week, we will continue on our journey towards establishing financial goals that will place us in a better position to live financially responsible lives. Today, our focus will be on the importance of creating an emergency fund.
Some may think to themselves, “I thought this was the purpose of establishing a personal savings account. What’s the difference?” There is a difference. A personal savings account serves the purpose of funding our short-term, mid-term, and long-term financial goals. An emergency fund is for the purpose of providing funds in the event of an unforeseen life situation that is beyond our control (i.e., divorce, job loss, or unexpected medical expenses, etc.). Having an emergency fund allows us to address the financial portion of the event without having to interrupt our other financial goals.
According to Forbes, the ideal emergency fund account should consist of three to six months of our overall household expenses. In like manner to establishing our personal savings, we must determine how much of our income we will be able to deposit into the emergency per pay period. This should simple, right? Wrong. Unfortunately, having an emergency fund is less common than one would think. Research from the Federal Reserve Board has found out that 44% of adults needed to sell something or borrow money to pay for an emergency costing as low as $400.
Like most things, not everyone is a proponent of having an emergency fund account. In fact, it has been called “overly prudent” by some financial advisors. The justification for this, Greg McFarlane says, is that
“…the math doesn’t come close to working out on emergency funds…it would make far more sense to say…maybe you should focus on closing out an account or two that’s costing you 15%.”
The problem with this type of thinking is that most people cannot afford to clear their debt first before setting aside money for those “rainy-day” situations. In addition, what happens if someone engaged in this method and were suddenly confronted with an unforeseen emergency event while they are attempting to “clear their debt first”? Realistically speaking, health insurance and unemployment insurance does not cover the remaining costs of the total household expenses either as McFarlane has suggested. The end result would consist of the individual becoming a member of the 44% mentioned in the Federal Reserve Board’s report above.
In consideration of this, the idea is to establish a separate savings account similar to the personal savings account with the same benefits. All things considered, it is also not recommended that Certificates of deposit or investment accounts be used for emergency funds due to the financial penalties that may be incurred from an early withdrawal as McFarlane has suggested. Having ready access to the account is of paramount importance.
Ar first, this may be perceived as an impossible feat. However, once the amount saved over time begins to increase and emergencies arise, the benefits will outweigh the small sacrifices per pay period. We will be grateful for not having incurred additional debt to compensate for our inability to be better prepared in advance. Do not wait until tragedy strikes before making an informed decision to make preparations for emergency situations. Who knows? The emergency may never arise. But remember, it is better to have the money available and nothing happens than to have something happen and not have the money available.
In the upcoming weeks, we will continue to discuss the various ideas which could possibly assist each of us in attaining financial independence. Next week, we will be discussing the third financial goal of prioritizing our retirement accounts. I would appreciate any feedback from anyone as this is a community effort to living our best life in honor of the One Who has given us this life to live. Love God…love others….love yourself!
Sean Mungin, author of “The Thorn In The Flesh”