{"id":4842,"date":"2018-01-29T14:30:00","date_gmt":"2018-01-29T19:30:00","guid":{"rendered":"http:\/\/innovativewealth.com\/?p=4842"},"modified":"2020-08-20T16:29:15","modified_gmt":"2020-08-20T20:29:15","slug":"your-emergency-fund-understanding-the-importance-of-cash","status":"publish","type":"post","link":"https:\/\/innovativewealth.com\/financial-planning\/your-emergency-fund-understanding-the-importance-of-cash\/","title":{"rendered":"Your Emergency Fund \u2013 Understanding the Importance of Cash"},"content":{"rendered":"

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\"emergency<\/a><\/p>\n

\u201cNever spend your money before you have it.\u201d\u00a0<\/em> -Thomas Jefferson<\/p><\/blockquote>\n

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Have you ever lost your job? Has your car ever required an expensive fix? Have you or a family member ever need funds for a hospital visit?<\/p>\n

Now imagine that you didn\u2019t have access to cash to pay for that emergency. What would you do?<\/p>\n

The mass issuance of credit cards has allowed people to neglect the need for an emergency fund. This is a mistake. An emergency fund is not only about preparing for the rainy day that you will need the funds. It is also about reducing risk, providing you options, and helping you sleep better at night knowing that your financial emergencies do not have to be debilitating.<\/p>\n

According to Go Banking Rates<\/a><\/span>, 71% of Americans have less than $1,000 saved in their savings account. Although some age groups vary by a small margin, 70%+ of them (including seniors) have less than $1,000. If their income is cut off for even a few weeks, how are they going to survive?<\/p>\n

\"what<\/a><\/p>\n

What is an emergency fund<\/strong>?<\/h1>\n

An emergency fund is cash that you have saved that has no other purpose than to protect you from an emergency that requires cash immediately. This is one of the most commonly ignored components of financial planning<\/a><\/span>. Whether it is clients we work with or new prospects, most people do not have an emergency fund. They consider it a waste of resources. Why have a pile of cash that you cannot spend just sitting there?<\/p>\n

The nature of an emergency is that it is unexpected, urgent, and requires immediate attention. If your car dies and you need it to go to work, that is an emergency. If you get in an accident, you will need to pay for medical care. If you lose your job, you will need money to pay your bills. All of these events are urgent, unexpected, and require immediate attention. If you are not prepared for them, then you will be stressed and worried about the short term problem rather than focusing on solving the long term problem.<\/p>\n

If you lose your job, immediately your primary concern is about how you are going to pay your bills. Until you have this figured out, you will not be focused on finding a new job. Finding a new job should be your primary goal. However, if you spend all your time on your short term need, you will not have enough time to find a new job. This is what I would call short term vs long term thinking.<\/p>\n

Short Term Funds<\/strong> vs. Long Term Funds<\/h2>\n

There are some small emergencies like needing to replace a tire on your car. Then there are large emergencies like needing to replace your car completely. Most of the larger emergencies require a short term<\/strong> and long term<\/strong> solution. Here is an example.<\/p>\n

If your car breaks and is not able to be driven, you will need to either fix it or get a new car. Buying a new car is usually an expensive option. It may be necessary, but typically it is also costly. Many people choose a short term solution until they have the time to solve the long-term problem of the broken car. A short-term solution might be to fix something that gets it running, but won\u2019t last for more than a month when it will be back in the shop.<\/p>\n

Your emergency fund will allow you to pay for the short term fix so that you can explore your options of buying a new car. If you are buying a new car, you probably want to take some time to research it first rather than being forced into a new one just because you don\u2019t have a substitute.<\/p>\n

How does financial planning<\/strong> help when you are building an emergency fund<\/strong>?<\/h2>\n

One important point to remember is that many \u201cemergencies\u201d are not actually emergencies, they are foreseeable expenditures that happen unexpectedly. Buying a new car every 5-10 years is a foreseeable expenditure. You may not know when your car will break, but you should know generally how long it should last.<\/p>\n

This type of money should be saved based on a realistic financial plan or budget. If you know you will need $10,000 for a new car in 10 years (based on the car\u2019s life expectancy), then you can save $1,000 a year to reach that goal. If your car breaks in year 9, then you will be much closer to your \u201cemergency\u201d need than if you had not planned at all.<\/p>\n

The best way to plan for large expenditures in the future is to account for them in your yearly household budget. If you budget properly, then you will not stress about not having enough money for \u201cemergency\u201d expenses.<\/p>\n

\"emergency<\/a><\/p>\n

What is a reasonable emergency fund amount to keep<\/strong>?<\/h2>\n

This subject is up for debate. Most financial professionals will give you a standard answer of 3-6 months. This has been the standard for a long time. However, it is dangerous to rely on rules of thumb.<\/p>\n

The financial services industry has some notoriously out-of-date rules of thumb that are dangerous if they are not used with some thought to what they are trying to accomplish. Here are some examples.<\/p>\n

Many people have said, \u201cYou should have your age as the percentage of bonds you own of your portfolio\u201d. This may be fine on the surface, but when used outside the classroom, it can endanger your portfolio. Here is an example. Currently, in the US there is a ZIRP (Zero Interest Rate Policy) meaning that if you want to put money in the bank you will get close to zero percent interest on that money. If you wanted a higher yield and put your money into 30 years Treasury bonds, you would get a higher rate, but you also risk losing money if interest rates rise. You would also miss out on getting higher rates in the future if rates rose.<\/p>\n

Another example of financial rules of thumb being wrong. How much should you have in your emergency fund? The rule of thumb is 3-6 months. However, at closer inspection, you will realize that 3-6 months of income varies per household.<\/p>\n