My latest monthly newsletter (sign up here!) focused on several financial rules of thumb that really aren’t one-size-fits-all. So many tried and true approaches just don’t apply to every last one of us — which is exactly why Willow Planning Group focuses on tailoring financial plans to fit each client’s personal financial situation.
Many of my clients ask how much they should have in an emergency fund. They are on people’s minds more and more as we’re in yet another month of the pandemic. And while the traditional maxim says you should set at least three to six months’ of savings aside, the amount that’s right for you really depends on your own personal situation. There’s two sides of the spectrum — you want to have your financial bases covered, just in case, but you also don’t want to miss out on alternative investment opportunities. Even the highest savings account rates right now are hovering at 1% APY at the max. There’s a happy medium for most of us.
Estimate Your Savings Target
For your tailored emergency fund needs, first consider the bare bones monthly expenses you’d need to cover in a true emergency. Beyond your mortgage or rent, utilities, health care costs and grocery expenses, what are the additional bills you’d have to pay? And what would you include for discretionary funds?
If you’re having trouble sorting out your discretionary vs. non-discretionary spending, consider taking a deep dive on your budget — it’ll be time well-spent! (I’ve seen people pay their mortgage or car loan twice in one month and didn’t know it until we reviewed the last three months of spending.) Once you get your monthly total, multiply it by however many months you’d like to be covered for, just in case.
Consider Emergency Fund Alternatives
Having a pile of cash sitting in a liquid account can be a tough standard to meet, especially if you’ve got competing goals. Consider whether accounts set aside for long-term goals like buying your first home or saving for that epic trip could be diverted for emergencies, if the need arises. Whether you feel comfortable investing that money, especially during these uncertain times, really depends on your risk tolerance and your overall financial picture.
If you have retirement savings in a Roth IRA, that can actually double as an emergency fund. Because you already paid taxes on the money you’ve contributed to a Roth IRA, you can withdraw your contributions any time, without penalty. But if you’re looking to withdraw from Roth investment earnings, several rules apply, and you could face withdrawal penalties. Importantly, this move doesn’t come without a downside — any time you take funds out of your retirement accounts, you are missing out on potential future growth.
If You Need Help Getting Started
If you’re entirely new to the savings game, it’s okay if you start small, just start! Pay yourself first when you get a paycheck — set it aside, and forget it. Make it less painful, and impossible to forget, by setting up automatic deposits from your paychecks into your savings account. Some employers will let you split your direct deposit off into separate accounts, so you won’t be tempted to “skip” a month. Even if it’s $10 per paycheck, do it! You can make small increases as you review your spending or receive pay increases over time. If extra cash ends up in your account at the end of the month, transfer it over to accelerate your savings.
If Your Cushion is Over-Stuffed
If you’ve followed the advice to set it aside and forget it, and now your emergency fund is a lot bigger than you need it to be, don’t be tempted to splurge it away! It’s time to revisit your goals and see where the money could work hardest for you. First, make sure you’re maximizing any tax-savings opportunities: Are all of your retirement options maxed out? Are you contributing to an HSA if it’s an option? Once you’re covered there, consider opening a brokerage account, putting the cash toward a new or ongoing goal, like a new home purchase, or tackling any other big projects you’ve been considering. There’s no shortage of options.
Kelly Luethje is a CERTIFIED FINANCIAL PLANNER™ professional and founder of Willow Planning Group, LLC. She provides financial education and guidance to help you live life on your terms. Kelly can usually be found on a mountain, or by a lake, working virtually with clients across the country.