We all have moments where we wish that we had some extra spending money or could afford an indulgence that we may not normally be able to enjoy. However, the situation is completely different when you can’t even afford the essentials—rent or groceries, for example. An emergency fund is designed to have you prepared for just such a situation, and is an essential part of both individual and family financial planning.
The idea behind an emergency fund is that if you are ever in dire straits—which was the case for many families after the market crash of 2008—you will be able to have money that is liquid, available and guaranteed.
“As a general rule of thumb for any household, it is always critically important to have at least three to six months of monthly expenses put away in a liquid account to have access to at any given time,” says Eric Meyers, the cofounder and chief executive officer at Capital Financial Group, Inc. “For an emergency fund, it would be a savings account or something else that’s guaranteed and not susceptible to market changes.”
“The idea,” he adds, “is that in the case you lose your form of income, you will be able to take care of monthly expenses. …You want to have a base sum so that you can give yourself the time to find a job and make your way through the application process.” Essentially, you want to be able to provide for everything that you could need while you might be in a financial limbo.
David Blackwell, who has been working in banking for 11 years, compared the building up an emergency fund to how a parent would go about building a savings account for a child. Just as with a savings account, Blackwell says that “the earlier you start saving, the better off you will be in the future. You can start with a parent making deposits into an account before a child is even born. The longer you have the account, the more it grows from interest.”
“A lot of people don’t think about it, but kids should be learning from their parents,” he continues, “making sure that their money is ensured and that they can cash it out.” According to Blackwell and Meyers, starting an emergency fund and savings account earlier rather than later is essential to preventing this type of problem.
For Blackwell, one of the most effective systems that he has seen for teaching children about finances and an emergency fund came when he was volunteering at an elementary school.
“Every Friday would be bank day,” he says. “Kids could bring in change to buy snacks and stuff at recess. However, they also had a bank. Kids could use money that their parents gave them to make deposits.” So, kids could buy a piece of candy, or other snack, but also deposit any leftover change for candy in the future. The school even handed out “penny checks” to help the kids track their accounts, Blackwell says. “It really gave them the mentality of wanting to save.”
When it comes to an emergency fund for a family, having three to six months’ worth of income accessible at any given time is a tremendous asset. However, it is also still a barebones, minimum recommendation. The larger the emergency fund is, the more time and money you have to make sure you can get yourself back on track in the case of unforeseen circumstances.
According to Meyers, having an emergency fund with only three months’ worth of expenses is fine if you have some other safety nets around you—perhaps a retirement fund or stock options. Without that, though, Meyers says six months’ worth of expenses saved “is much more important.”
When it comes down to it, an emergency fund is based solely on the idea of security. It is much better to have a lump sum of liquid money, be it cash or savings, than to have to rely on assets such as property, stocks or bonds. As Meyers puts it, “When market security is compromised like in 2008, why would you put your assets at risk?”
Markets rise and markets fall, so it’s never too late to ensure you’ve covered your bases.