How Much Should Your Emergency Fund Be?

     In life, we should expect the unexpected. I have had my share of unexpected events that resulted in financial difficulties and have seen many families get struck by the financial burden of unforeseen expenses. It doesn’t matter how much money you make or how well you plan, bad things can still happen. According to a survey conducted by the National Foundation for Credit Counseling in 2011, 64% of Americans do not have the money to pay for an emergency that costs $1000. Seventeen percent of the respondents said they would borrow from family or friends while another 17% said they would just have to neglect existing financial obligations. Either way, having insufficient savings in a special account for emergencies can and will drive you into debt. The added debt then creates another set of problems that exacerbates an already tenuous and fragile financial condition. 

     The years 2008 to 2013 were very challenging for my family and I. There were many unexpected things that happened during those years. They are too numerous to mention in this blog but what I can say isthat they were all significant and life changing. The end result of these events is that it wiped us out financially. In the beginning of 2008, I thought I was set. I had a great job and was on my way to celebrating 13 years with my company, a great income (the most I have made in any previous job), and a lot of cash in the bank, since my income far exceeded my expenses. Then, I saw it all disappear over a period of one year. The catalyst of my challenges was the Great Financial Crisis. It's a familiar story that I and many of my friends in the real estate and lending industry can now reflect on with an attitude of gratitude, because we survived it and can share the story with others. It was a difficult time for me personally, professionally, emotionally and spiritually.

     What I learned through these challenges is that I saw life through rose-colored glasses and thought it almost inconceivable that anything negative could happen to me that I would not be able to handle or fix. I was wrong and naive. The best thing anyone can ever do in life is to save money and establish a substantial emergency fund because anything can happen. For me, it was financial and employment but it can be health or natural disaster. You have no Idea what kind of life trauma is waiting for you when you leave the house in the morning to start your day. Having an emergency fund is an important step to take to safeguard your financial stability. The idea is to have money that you cannot touch unless you are faced with a major unexpected event. Note the word “major”. Financial emergencies can come in the form of medical expenses, job loss, home maintenance and auto repairs. Funeral costs and legal costs can also be a form of financial emergency. The last thing you want to do is to take out a loan just so you can pay off the emergency. You also may not qualify for a loan if your life event is unemployment.

How much is enough?

     Exactly how much you should keep in your emergency fund is up for debate. But I would have to agree with most experts that claim that an emergency fund should be money worth three to six months of your living expenses. However, this will still depend on a person’s situation, whether or not you already carry substantial debt or if you have children you need to sustain. 

     But the less stable or uncertain your income is, the more you want to add to your fund. Even if you lose your job, you still have bills to pay and if luck is not on your side, it might be awhile before you find a more suitable and stable form of employment. I stumbled upon an Emergency Fund Calculator at http://www.calcxml.com/do/bud03 which helps people determine the right amount of an emergency fund given a person’s monthly expenses. 

Start now

     Many people will argue against this strategy by saying that there is no way you can start an emergency fund while trying to pay off credit card and auto loan debt and starting a 401k for retirement. Please take my advice and stop the 401k and start the emergency fund. Start paying off your credit card debt and installment auto loans. Use every penny you have to get rid of debt. Under no circumstances should you ever finance a car. Pay cash and buy a used car. Start limiting your entertainment expenses to home activities and stop eating out. Until you have an emergency fund, your 401k is an expensive emergency fund just waiting to charge you a 10% penalty for early withdrawal, in addition to the taxes they are going to take because what you have saved is no longer deferred. 

     Accumulating 12 to 24 month’s worth of expenses can be challenging and it will definitely take some time. But it is always better to start now than never. Start small by saving something manageable. Look at your monthly expenses and look for areas you can trim. Make it a habit of depositing regularly into the fund either on a weekly, bi-weekly or monthly basis. When you get your paycheck, automatically put some money into that fund and forget about it. After a couple of months, you’ll be surprised to know that you have achieved your goal after all. 

Where to keep it?

     One of the hardest things about keeping an emergency fund is actually keeping the money intact. It can be difficult to resist the temptation of getting a couple of dollars to buy something you want. So instead of giving into the temptation, open a new savings account. It is easy to use and does not really cost you anything to maintain it. Keep your emergency fund in a place that will be fairly liquid so that you can have access to the fund when you need it the most. Do not tie your emergency fund into stocks or mutual funds or put the cash in your sock drawer. 

     The good news is that once you have saved enough for the emergency fund, you can finally start putting money into investments or maybe better transportation. You will sleep better at night knowing that you do not have late fees, overdraft charges or missed payments to worry about. We cannot control everything that happens to our lives but we can control how to deal with it. 

     Today, things are much better. I have a great job, great income and I have an emergency fund that I am building back up to a level I haven't set yet. My emergency fund will significantly exceed my previous emergency fund because I have learned from my past experience. Today I believe that I cannot save enough money, especially now that I am looking at retirement in the face within the next 15 years. My savings and my emergency fund were wiped out between June 2008 and June of 2013 because I underestimated how tough it would be and how long it would take for me to recover. We lived on our savings until it was gone and Hope was all that was left. And we all know that Hope is not a strategy. You need a strategy when property values drop, the unemployment rate increases, your tenants stop paying the rent, your job shuts down and your new job is 30% of your normal pay. You need a strategy and you need one fast. 

Stay out debt and pay your taxes

     I learned many invaluable lessons that I am very thankful for today. The most important lesson I learned is that debt is a monkey on your back, and I mean all debt, which includes a mortgage, auto loans, and credit cards. It is now my priority to pay off my mortgage and I will never finance a vehicle ever again in my life. I will never carry a credit card balance more than 30 days if I use the card at all. My strategy is to stay debt-free and to live within my means. I have grown up and do not need all the trappings of success to feel successful and to be successful. Today I am more humble and more thankful for what I have and the people in my life than I have ever been. Secondly, I have learned to pay my taxes. You can run but you cannot hide. It makes no sense to go into extraordinary mortgage debt in order to reduce your tax liability. It is a serious gamble with your life and just like they say in Vegas, “the house always wins” well the government always wins. Buying a home does decrease your tax liability for as long as you are making the money to pay the payment. When the income stops it all comes crashing down like a house of cards. So buy responsibly and minimize the risk by not allowing more than 25% of your net income to go towards your mortgage payment, maintenance and utilities in total. This may mean that you need to rent for awhile until you save enough money or earn enough money to buy a home. If most people lived by this rule, they would be living in much smaller houses or in different neighborhoods. But they are keeping up with the Jones' and are going broke. One day, they will wake up from their narcissism and see the broke they can't see right now. I want you to see it now. They also see the "broke" now but they are more concerned about the present and appearances than the future and their preparation. There are many other lessons I have learned but you will have to catch me on my book tour. So I am going to stop here. 

     We all need an emergency fund, but the days of “6 months of whatever it takes to take care of your household is the right amount” are over. You need no less than 24 to 36 months and then you can start saving for retirement. This is my opinion, especially if you are a high-income earner, because it will take you longer to find a job. So if you need 3k to 5k a month to take care of the household expenses, then that means you need to have 180k in a very liquid and accessible bank account. Now I know what you are going to say: "There is no way I can save that much money.” So my answer to you is to live a more frugally and save more money. Maybe 12 to 24 months will do it for you if you really cut back on spending—but you will not. 5k a month for a family is not a lot of money but I know many people who have been out of work for over two years or became ill and cannot do the same kind of work that they used to do. An emergency enables you to have a soft landing. It buys you time to figure out what you are going to do. It gives you time to liquidate other assets, including your home, without the stress and the vultures who know your circumstances and offer you fire sale prices. I know many people are going to disagree with the numbers I am proposing. I am just telling you what I have experienced and how I am preparing myself for the future. My new problem is that I am in such great shape because I eat right and exercise that I am worried now about living too long and running out of money at the same time the government does. Save your money and your money may save you when you need it the most. Your Power Is Now because The Power Is Now.