Break in Case of Emergency

Break in Case of Emergency

A while back, I discovered something no homeowner ever wants to discover: My water heater’s tank failed in spectacular fashion. After a frantic phone call or two — by the wee hours of the next morning — I had most of the water collected in a wet vac, the carpet pulled up leaving the pad exposed, and an industrial size dehumidifier running.

“Phew,” I thought, “I got it licked.” And thankfully, by that afternoon, I managed to get the old water heater out and a new one in, up, and running.

Although I got no sleep that night, it’s great because it’s a lesson we can all learn from: the importance of having a financial emergency reserve.

Preparation is key

The fact is that an emergency reserve is so critical to everyone’s financial plan that it should be savings goal number one in almost all cases across the board. Without an emergency reserve, an immediate unforeseen $1,000 need — for instance, like a water heater failing — the options typically involve taking on debt or stopping contributions to other longer-term savings goals.

Taking on debt can prove costly, of course, and stopping contributions to long-term savings goals can present problems — magnified by the loss of several periods of compounding return potential.

The big question

When I mention the idea of an emergency reserve to a client in practice, often the first question I hear is, “How much should I have in my emergency reserve?”

The truth is that it is somewhat subjective, but there are some good rules to follow that can help in arriving at a number.

Yes, you can even have too much of an emergency reserve, meaning you have money hanging around doing very little for you that could be better applied elsewhere in your financial plan.

The baseline starting point for an emergency fund is three months of expenses. If you were starting from $0 today and just needed to go somewhere as a goal for an emergency reserve, three months of expenses is a great start. The key here is to focus on your expenses, not your income when determining your target number.

Now, if you’re a single-source-income family with kids and that source of income is variable, for instance being paid on commission or relying heavily on bonuses, the target multiplier is probably six to eight months of expenses.

Taking into account your family’s income source scenario, the number of mouths to feed, and more, you’ll probably find that you’ll fall somewhere in that range. However, once you have more than a year’s worth of expenses just hanging out in a basic savings account, you’ll also probably find that you’re better served doing something a little more productive with that excess.

Looking for more guidance on how much to save for emergencies? Ready to invest the excess cash in your emergency reserve? 

If you have questions about adding an emergency reserve to your financial plan or managing those just-in-case funds, just ask! Interested in meeting to begin the path to your financial future? We’re accepting new clients, and you can start with a no-cost no-obligation web or in-person consultation.

Jason Speciner
Jason Speciner
jason@fpfoco.com

Jason Speciner is a CERTIFIED FINANCIAL PLANNER™ professional, an Enrolled Agent, and the founder of fee-only firm Financial Planning Fort Collins. He is also a member of the National Association of Personal Financial Advisors (NAPFA), Financial Planning Association (FPA), and XY Planning Network. Since 2004, he has served clients of all ages and backgrounds with unique experience working with members of generations X and Y. To learn more, check out Jason's blogs and see the media he's been featured in.