Building Your Estate: Emergency Funds

November 17, 2010
300px Em cycle Building Your Estate:  Emergency Funds

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Second in an occasional series about foundational financial planning strategies.

What is an Emergency Fund?

An emergency fund is an amount of money you set aside that only used for a “rainy day” – unexpected events that must be handled financially.

What exactly constitutes an emergency will vary from person to person, but would include illnesses, accidents, job losses, or breakdowns in the home (like a furnace, dishwasher, roof, etc.).  It does not include vacations, HDTVs, college, etc.  Saving for these goals or items should be done separately.

Probably the worst emergency of all is an unplanned death.  Having available cash where there is little to no cash or life insurance left for the family can be a great help towards getting the family back on its feet.  Some help is provided in most state laws – family beneficiaries may use portions of the decedent’s estate while it is being administered.  This concept will be further detailed in a future post.

Do I Need One?

Before our Great Recession, some argued that an emergency fund is unnecessary.  They stated that since savings rates are so low and higher rates of return could be achieved in the market, you should instead invest all excess cash and use any available credit to cover emergencies.

However, after the events of the last 2-3 years, most would likely agree nowadays that having some cash set aside is a strong trump card against market, credit and employment risks.

So yes, you need one.

How Much?

This depends on your assets, insurance, stability and risk aversion.  Any one or combination of the following should be considered:

  • Fixed amount of cash – Such as $1,000 or $5,000. This is most popular with those in debt or younger adults because it is the easiest to achieve.
  • 3-6 months of expenses or salary – This choice is the most popular with financial advisors, since you would have coverage during periods of lost income.
  • Percentage of assets – This strategy is generally reserved for those who are financially independent.  To them, the funds are also viewed as “safety” investments in their portfolio.
  • Deductibles – This involves setting aside the total of all deductible amounts in your auto, property and health policies, with insurance covering the rest.  The problem with this method, of course, is being able to foresee and pay for what is not covered.

Where Should I Keep It?

Because the emergency usually results in an immediate need for cash, the source of funds must be highly liquid.  In other words, it should be as simple as possible to get to and use the money.  The three main choices:

  • Cash – Usually held at your bank, credit union or in a money-market account.  The best choice in most situations.
  • Stocks or Mutual Funds – While liquid and having the potential to earn more savings, if the market is slumping, you are forced to sell these assets low.
  • Credit – Having available a credit card or a home-equity line of credit is also an option (as discussed above), although using either one will add debt.

Which is More Important:  Debt or the Emergency Fund?

The debt.  Paying down debt is required; funding for emergencies isn’t.  Behaving otherwise will negatively affect your credit.

However, do not ignore the great benefits, financially, emotionally or otherwise, of using cash and no additional debt to cover emergencies.  In fact, if you have debt and no emergency fund, you should really try to attack both.  One way to approach this is by treating the emergency fund as a “debt” that you must fund at least minimally each month.

In any event, the sooner you control both, the smaller the impact of future crises will be.

 Building Your Estate:  Emergency Funds
 Building Your Estate:  Emergency Funds

Scott

Scott R. Zucker, Esq. is the owner of The Zucker Law Firm PLLC, located just outside the Capital Beltway in Annandale, within five miles of the City of Fairfax, the county seat of beautiful Fairfax County, Virginia. The firm focuses mainly on estate planning services for Virginia, Maryland and Pennsylvania clientele, and seeks to do so in an affordable and approachable way. People interested in learning more can contact Scott by phone or email.

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