Jonas Gunnarsson, Getty Images/iStockphoto
What's it going to be this time? Will the transmission on the Audi go out? Will the company downsize? Will somebody have an accident or a rare disease?
For Miranda Marquit, a freelance journalist in Logan, Utah, it was a basement flood.
These are the unexpected shocks that can devastate income, cash flow and credit scores. And they can happen to anybody in the months and years ahead.
They could happen tomorrow. They may even happen on the way home from work. This is why financial planners, gurus and experts all advise having some sort of emergency fund — money set aside to smooth out the financial bumps that can't be anticipated. But knowing how much is enough to offset the unanticipated and knowing where to keep that money are open for some debate. A study recently published in the Journal of Financial Planning, "Is an all cash emergency fund strategy appropriate for all investors?" has found some new twists that challenge some previous assumptions.
Leanne Kramer, a certified financial planner and certified investment management analyst in Olympia, Wash., says emergency funds are the way to buy time to find a job when you lose your job. "Hot water heater go kaput the same time your car needs a new head gasket?" she says. "Emergency savings will help you there. It is specifically for the unexpected emergencies that come up. And they do come up."
Kramer also says emergency funds can break the cycle of credit card debt. "If you have a cushion," she says, "you won't need to use a card to pay for the unexpected."
The standard advice for emergency funds is for people to have three to six months' worth of expenses set aside in an easy-to-access fund, such as cash in a savings or checking account. Some experts, such as Kevin Gallegos, vice president of Phoenix, Ariz. operations for Freedom Financial Network, bump it up to six to nine months of living expenses. "While that may sound daunting," Gallegos says, "it is an attainable goal, even in challenging economic circumstances. The key is to start with what's 'just enough.'"
Jacob Sybrowsky, a co-author of the study on emergency fund strategy, says, however, that even though the standard advice of three to six months' expenses isn't based on real science, it is still probably good advice. "I don't want to fight against it for the average family," says Sybrowski, an assistant professor of personal financial planning at Utah Valley University in Orem, Utah. "We definitely advocate a proper emergency fund. But with a little more detail, we can do a lot more."
Part of that detail deals with how much to set aside. Another part looks at where that money should be kept.
How much to set aside
Gallegos says the amount of money to start an emergency fund can be small. "Think about the level of expense that causes you to rush to a credit card," he says. "That is the amount to start with. Have at least that available, and build gradually toward six or more months' living expenses."
Sybrowsky says although an emergency fund may have many uses (such as Marquit's basement flood) some say its primary use is in case of job loss. He says to look at expenses and income and figure out what income needs to be replaced in case of sudden unemployment. Some expenses may drop right away. You don't pay taxes on non-existent income, for example. Vacations may be out.
The time period for those expenses may also vary. In a good economy, it may be three months. During the recession, people averaged a longer time to find a job, so nine months may have been the target.
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