My son Matthew earned his Eagle Scout several years ago. The Eagle Scout motto is “Be Prepared,” and the program’s focus is to help boys and girls be ready to face various challenges in life. I was thinking of that training often this past week when Texas was faced with freezing temperatures, snow, and ice. While the snow and ice were beautiful, it also reminded us that the basic physical requirements for living are food, water and shelter.
In financial aspects, it’s critical to be prepared for the “certainty of uncertainty.” There are basic steps we can take to be ready for whatever life brings to each of us. Let’s focus on the immediate needs today, and we’ll discuss preparation for the longer term in upcoming articles.
One of the foundational principles of being financially prepared is to have an emergency fund. This is a cash reserve that can be used to cover unexpected expenses like a copay for health insurance, a car repair, replacement of a major appliance or air conditioning unit, or any other immediate need. It’s important to keep in mind that this fund is only for a “need” and should not be accessed for a “want.” You may “need” to repair your car, but buying a new car is most often a “want.” Emergency funds should be used wisely and sparingly.
A rule of thumb is to have 3 to 6 months of living expenses set aside in a checking, savings or money market account for your emergency fund. So, if your essential bills total $3,000 per month, then work to accumulate $9,000 to $18,000 in an account if you do not already have this amount set aside.
Some of you who are reading this are probably thinking, “I don’t have $500 in savings, much less $9,000!” Saving part of what you earn is a habit. It’s an essential habit. Bluntly, it’s probably the biggest difference between the financially strong individual and the individual who constantly struggles to make ends meet. I’m empathetic to people going through a difficult time and can’t save during some period in their lives. I have personally been through a time when I was focused on meeting my necessary expenses and couldn’t save. But those periods should typically be a few months or maybe a few years, not 5, 10, or 20 years. Saving money from each paycheck is a step forward. Spending all of your paycheck is two steps backward.
Many people find it helpful to separate the emergency fund from their accounts that they use daily, like a personal checking account. You can open a savings account with your bank or credit union and set up automatic transfers each pay period into the emergency fund account. Because interest rates are at generational lows, you will probably earn very little interest putting funds into savings and money market accounts. But making money is not the goal of this account. The primary goal is to have savings in an account that has safety of principal so you can access it in an emergency.
I do not recommend using a line of credit, volatile investments, or insurance products with surrender or loan charges for emergency needs. A line of credit may not be available for you in an emergency. A growth stock or mutual fund can fluctuate greatly in value. If you need funds when financial markets are lower, you may be forced to sell investments at a loss. Insurance products like annuities and permanent life policies can often be accessed, but at a cost. Know the cost of liquidating an annuity contract or life policy before using that option.
Who knows when the next polar vortex may put south Texas in a deep freeze? Or when the refrigerator or fuel pump in your car might go out? Regardless of uncertainty, it is my firm belief that when challenges arise, having a fully-funded emergency account will help you deal with uncertainty. It’s an essential part of “being prepared.”