Good morning and happy Monday! I’m excited today to have written my first guest post over at My Family on a Budget – be sure to go check it out if you haven’t already.
Emergency funds. We all hear that you should be keeping 3-6 months of expenses in a savings account or some other easily accessible account. But many of us don’t like doing that. Not only is it hard to set aside that much money, but you also don’t earn anything on it given how low interest rates are today. Wouldn’t it be better to simply invest, and make more money?
No, You Should Not Invest Your Emergency Fund
In the story I share over at My Family on a Budget, I tell you all about the event that changed my life four and a half years ago. When my husband woke up from his coma in the ICU, the next day he called me in a panic – worried about how we were going to pay for everything. He had been in a coma on a ventilator for a week. I was out of work to be with him, and missing my MBA classes. His unemployment ended because he wasn’t able to file while in a coma – and he wouldn’t be able to even look for work for about a year afterwords.
“You’re worried about money?” I said incredulously. “Don’t worry about money! It’s all taken care of. You worry about getting better.”
This is a key point, so I’ll repeat i t. When you are sitting next to your spouse on a ventilator in a coma, hearing “it’s cancer” from the doctor, having your boss tell you that times are tough for the company and they have to let you go, or seeing a tree go through your roof-you don’t want to have to worry about money.
As you’ll often hear on the Stacking Benjamins podcast, you need to remember that your emergency fund is not an investment. It’s insurance. You don’t expect to make money on your insurance (and if someone tries to sell you a product that promises to make money on your insurance, you need to run). Insurance is there in case something bad happens, to protect you. Your emergency fund is your insurance plan to take care of both the mundane but expensive, as well as the catestrophic and unthinkable.
Sometimes people will fall into the trap of thinking that “it can’t happen to me”, “my job is secure”, or “I rent, so I don’t need an emergency fund”. I was only 31 years old when my husband nearly died, and I can tell you that cured me of the “it can’t happen to me” syndrome. Yes, it can happen to you. Even if something goes right 99% of the time, there are real people inside that 1% that goes wrong. And if you’re in that 1%, you don’t want to have to worry about money when your life is falling apart.
Developing Your Emergency Plan
As I mentioned in my post over at My Family on a Budget, it was not just the emergency fund itself that saved our financial lives. It was executing on our emergency plan. Now this is something you should have in your back pocket whether or not you’ve fully funded your emergency fund. Whether you have a thousand dollars or a hundred thousand dollars, you should set aside some time to plan out your financial strategy in case of catastrophe.
You see, an emergency is not always a simple one-time expensive event. The expenses can go on for months and months. Suddenly and unexpectedly, your income can go down while your expenses shoot through the roof. You can use your emergency fund to pay for those monthly expenses, of course, but decreasing your expenses or increasing your income quickly will help keep the draw-down to a minimum.
You’ll need to find quick ways to do three things:
- Increase your income
- Decrease your expenses
- Tap other sources of money
Lets examine each of these in more detail-then set aside some time this weekend to work through your personal emergency plan.
Increase your Income
You’ve lost your job, or a loved one has a medical emergency and you need to be out of work for a while. Or your beloved pet needs an expensive surgery and rehabilitation. How can you increase your income to deal with this? Part-time jobs, consulting jobs, online sources of income can help. Managing to earn even small additional amounts of money can mean the difference between paying your bills and not. Are you totally dependent on only one income source? If so give some thought to whether you can either diversify your income streams today (by side hustles or a part-time job). If it wouldn’t be possible today, give some thought to how you might do it if the need came.
Say you didn’t lose your job – how can you increase your income without a raise? In my story, I shared how we stopped contributing to college funds and dropped my retirement contribution back to only enough to get the match (and I would have stopped it altogether if I had to). This gave me an instant 12% or so boost in my after-tax income without changing my salary. This is how living below your means and consistently setting money aside every month gives you not only financial assets, but financial flexibility. You can give yourself an instant raise-and then take it away again-within days.
Decrease Your Expenses
Decreasing your expenses can be done at any time, but it’s even more important during an emergency. We all have some expenses that represent wants, not needs, or perhaps represents a need but we pay more than we have to. And ordinarily that’s fine-eating out, cell phones, cable, etc. may make your life more enjoyable. However, it’s important to have a clear sense of which expenses you could cut or cut down in the event of an emergency situation. Make a list of those expenses and save it to your computer now, while everything’s going well, so if something goes wrong you won’t need to think about what to do. Check everything – your car and home (renters) insurance, your home phone, your internet, cable, cell phone. Eating out, new clothes, groceries, etc. They should all be on the list to either cut or cut down in an emergency. Also look at options to refinance any debt (student loans, mortgage, credit card, car loan) to decrease your monthly expenses.
Tap Other Sources of Money
Your emergency fund doesn’t need to just be one big pile of cash sitting in a savings account at your local bank. “But wait Liz,” you’re thinking, “didn’t you just say above to never invest your emergency fund?” That’s correct, I did, but that doesn’t mean that you can’t earn over the paltry 0.02% your local bank may be handing out. You can have a tiered emergency fund, with a certain amount of expenses in each tier, in addition to a plan on the order in which you would “break the piggy bank” if needed.
What on earth does this mean? Let’s break down five possible tiers you can use.
Very safe and very liquid.
Keep the first few months of expenses somewhere that you can get the money in a matter of days. You may even want to keep something like $1000 at a local bank that you can access immediately, but keep the rest in an online bank. Don’t settle for 0.02% interest when you can at least get 1%! Visit Magnify Money to check out the best online savings account rates
Very safe and slightly less liquid.
Keep the next few months of money here, where you can still access the money but it’s a little less liquid. Options here include CD’s, savings bonds, or government treasuries. On savings bonds you’ll currently be able to earn 2.76% on an Ibond – the catch being that you can’t cash it in for a year, and you will sacrifice interest cashing it in before 5 years. You can create a savings bond or CD ladder by investing a small amount every month over time, so if you need the money you can access it.
Once you have your emergency funds in place, know which accounts might be in your next tier of your emergency plan. This is where any after-tax investments might come in (NOT in tier 1 or 2). Since investments go up and down with the stock/bond/real estate market, you don’t want them to be your primary insurance policy. This may include things like your ROTH IRA contributions, mutual funds, stocks, or other investment accounts. However, if you’ve tapped out the first two tiers these funds could be your next option.
Sources of debt
. You’ll notice this is far down on the list, because adding on debt during an emergency is the last thing you need. But if you’ve tapped out tiers 1-3, debt may be your next good option. Credit cards, home equity loans, and personal loans may be an option. Tread carefully here though-creating new debt during a catastrophe can lead to bankruptcy. Only take on new debt if you’re confident the situation is temporary and you can pay it back quickly. If you aren’t confident of that, look instead to increasing income, decreasing expenses, or selling assets. You and your family may need to adjust to a new financial “normal”, and you don’t want to use debt to try and keep up your old lifestyle.
This is going in the last tier because it’s the least desirable option. Often times there’s a penalty for cracking open the piggy bank that’s your 401k, IRA, ROTH earnings, or 529. Hopefully this is the tier you never reach, because the penalties are steep and you’ll never be able to get back the compounding power of the account. By the time you hit this tier you should be looking at drastic lifestyle changes-selling your house and moving to something less expensive, selling your cars and buying something less costly, moving to a new area to find work. But this is the final tier of options and I want to make sure it’s on your list.
How Your Emergency Plan Can Save You
Knowing specifically how you’ll increase your income, decrease your expenses, and tap various sources of money gives you confidence in the security of your emergency plan. When something bad happens, you don’t want to be sitting in shock wondering what on earth you’re going to do. Instead, you want to be the person taking out your plan and knowing exactly what you’re going to do-because you’ve prepared.
Do you have an emergency fund, or are you still working on yours? How about an emergency plan? Let me know in the comments. Be sure to follow my blog (on the sidebar) for more great posts via e-mail, or follow me on Facebook, Twitter, Instagram or Pintrist.