Have an Emergency Fund? Don’t Set It and Forget It
6 second take: An emergency fund needs to be re-evaluated and adjusted on a regular basis to account for life changes that may affect your income and expenses.
If you’ve taken the time and effort to establish an emergency fund, you’re probably feeling pretty proud of yourself — as you should.
However, you shouldn’t forget about it after you build it. In order for an emergency fund to be effective, it needs to be properly and consistently stocked at all times. Life is always changing, so it only makes sense that your emergency fund will change, too.
Personally, my wife and I like to keep six months’ worth of our expenses in cash to cover any emergencies that may pop up, such as a job loss or medical expense. The amount you keep in your emergency fund may differ, but here are a few situations in which you should re-evaluate it to see if it’s enough.
You’ve Drained Your Emergency Fund
If you must use the money in your emergency fund, you should definitely evaluate how much you need to fill it up again.
Most people would try to fill their emergency fund to its previous level. However, this is the perfect opportunity to make sure that your amount is properly set.
Were you stressed that you wouldn’t have enough money when you had to use your emergency fund? If so, you may want to increase the amount accordingly, and alleviate your stress in the event that you use it again.
Your Expenses Have Changed
Your regular expenses will inevitably change as you move through various stages in your life. Common life events that result in major changes in your expenses could include buying or selling a home, moving from one rental to another, or getting a new job [that’s not an expense unless we mean relocating for a new job]. If your expenses have increased, chances are that you’ll want to increase your emergency fund as well.
My family’s expenses will be increasing when we build our new home, which means that my wife and I need to add additional cash to our emergency fund to adjust to the new mortgage payment.
However, if your expenses have permanently decreased, you may be able to take some money out of your previous emergency fund amount and invest it in a more productive manner. You’ll still want to keep six months’ worth of expenses on hand, however.
Your Job Stability Changes
Job stability was a huge factor in determining the size of our emergency fund. We felt that our current job situation was fairly stable, and that, as such, we could replace our income within six months of losing a job.
However, if we found out that one of our jobs suddenly became less stable, or that it would be significantly more difficult to find a new position, we’d consider increasing our emergency fund to cover eight — or even 12 — months’ worth of expenses to accommodate the time between employers.
You Add a Family Member
Growing your family can have a huge impact both on your expenses and your emergency fund.
When my wife and I became parents, we knew that we were going to have to increase our expenses increased to pay for the baby’s needs. We made an estimate of these additional costs and increased the size of our fund as such.
However, when you add another dependent to your family, whether it’s another child or an aging parent for whom you need to care, you may want to add another couple of months’ worth of expenses to your emergency fund to account for the pressure of new family, if you can.
How to Build an Emergency Fund
If you haven’t started building an emergency fund, assess how many months’ worth of expenses you want to save — as determined by your job stability, family size, and expected future expenses. Once you know your target amount, aim to put aside one-fifth of your take-home pay every paycheck until you reach that amount.
“The rule I tell my clients is to save 20 percent of net income and then live off the rest,” says financial advisor John Fiorito of RMR Wealth Management.
While you may be inclined to invest your money simultaneously during this period, focus on building your emergency fund before moving onto riskier, potentially higher-earning expenses.
“Don’t start investing unless you reach a goal of three to six months’ worth of fixed expenses,” Fiorto advises clients. “Once you have that, then you can begin to take the surplus for investments.”
If you can’t spare the 20 percent of your net income, there’s no shame in saving a lesser amount. Doing so can pay dividends in the hopefully unlikely event that you need to dip into your emergency savings.
I Have an Emergency Fund — Now What?
“Regardless of how much you’re putting aside at a time, money is money,” says senior wealth manager and financial planner David Flores Wilson of Watts Capital. “Life-altering circumstances can devastate you financially, and if the $50 you’ve saved in your piggy bank is the only thing that pads your blow, your later-self will thank you.”
An emergency fund is an extremely financially freeing tool. It allows you to relax a bit in the event of unexpected stress. Make sure you regularly re-evaluate your fund to make sure that it fits your needs.