A discussion on emergency savings isn’t generally the choice topic among those on a financial journey. In fact, in the world of financial planning, some of the most consistent questions I receive regarding the topic of emergency funds typically fall into one of two camps. First, “what’s the minimum amount I really need for my emergency funds?” Second, “how can I make the most interest/return on these funds?”
Effectively, the underlying opinion for many folks is that the emergency fund is a burden to their wealth-building journey. Individuals typically look at this fairly idle cash and become concerned that it’s not really doing anything for them. Yet, the reality is, an emergency fund is a great tool to help balance the overall risk in your financial plan. At the same time, the funds provide reserves which could be available to make the most of great opportunities that tend to come along with some irregularity in life.
Risks Often Strike In Groups
Whether you attribute it to the humorous forces of the universe or just the cumulative effects of bad luck, it tends to happen time and again that folks experience adverse life scenarios in rapid succession. Practically speaking, this is probably far from the truth, as most run-of-the-mill unfortunate events rarely catch our attention or make headlines. Still, most of us can recall periods in our lives or others’ where it seems that all at once nothing goes right. This could be a home maintenance event complicated by car trouble. Maybe it’s expensive medical bills in the midst of a downturn in financial markets. Or it could be a job layoff in the midst of an economic recession. And for some folks, it can be one scenario after another that seems to hit from every direction. The fact is, our lives are generally situated well to take on risks at an individual level, but when those risks compound one after another, the financial and life stress can magnify greatly.
Having cash set aside and easily available gives me peace of mind for these compound scenarios. I know I can cover an auto repair out of our family’s regular income or our auto savings account. But this naturally gets more difficult if there’s turbulence on the professional front or an economic downturn makes near-term income appear less certain. In volatile times like these, having some easily accessible cash can help provide mental peace from the other stressors in life.
Humans Often Overestimate Their Risk Appetite
When working with individuals of all ages, one theme seems to repeat as often as investment markets have their cycles of ups and downs. Broadly speaking, individuals typically overreach for return and underestimate the emotional toll of seeing their account values recede from highs, then remain lower for what can amount to months or years. It’s during these tumultuous times when an emergency fund can act as an emotional buffer to bad decision-making with more volatile investments. The fact is, if an individual has access to a chunk of cash for any immediate needs, they are much more willing to allow their long-term investments to go through the natural cycles of ups and downs.
I’ll admit, during times when investment markets seem to rise constantly and aggressively, I often look at my emergency fund and find myself annoyed by the barely increasing balance from low interest rates available on cash. However, when markets dip 15%, 20%, or more, as they tend to do from time to time, this cash gives me peace that I have some financial resources available for what life may throw at our family.
Opportunity May Appear in Gray Skies
By definition, an emergency fund is typically earmarked for those rare times in life when alarm bells sound, and you’re faced with unfortunate events. On the flip side though, there are times when the world around you can be going through a period of turmoil and others are forced to raise cash, reposition their portfolios, or are generally unable to look for opportunity in the moment. In the few times I’ve seen these types of events unfold in my life thus far, I’ve often wished I had a bit of opportunity cash on the sidelines to take advantage. The unfortunate reality is I’ve often been invested in the same downward spiraling assets as others in the midst of these storms. Over time, we’ve increased our family emergency fund to not only weather these life events less stressfully in the future but also be ready to consider decent opportunities should they come along.
Emergency funds overall are not the most exciting part of your financial plan and wealth development journey. In fact, it’s the simple fact that this account is so boring which suits it to be ready and waiting when the rest of your life becomes more exciting than you might prefer. For this reason, an emergency fund of some size is a vital part of every financial plan I put together.
In future writing, I’ll explore how I typically calculate emergency fund target levels before also diving into where I consider keeping my funds and why.