6 Months of Expenses in an Emergency Fund Instead of 3
It’s no secret that the COVID-19 pandemic from 2020 has altered how nearly everyone views money and savings. We went from an economy here in the U.S. that couldn’t be stopped to literally shutting down an entire economy and workforce and forcing citizens to stay home. That’s like stopping a freight train going 100 mph with full force immediately. It could also be said that during the financial crisis of 2008/2009, many people also learned valuable lessons about finances that forever changed them. So, how can we better ourselves now to make sure financial disasters don’t happen again?
As we went through many conversations with clients, the number one topic of conversation always resorted back to cash. Many client conversations started about by simply asking the question of, “How’s your cash position?” From our perspective, we want to make sure, regardless of employment/income, that all upcoming expenses and obligations are going to be able to be paid for. One of the most valuable elements of having cash on hand is to be able to provide for one’s family when an unexpected (emergency) event happens. So, for those who had cash, upcoming expenses would be okay. The last thing we would want to see is losing income and not having enough cash to cover bills, and then immediately resorted to consumer debt (like a credit card). While credit cards are not bad in and of themselves, using them to carry interest at something like a 20% interest rate can wreak havoc on saving for the long term.
The other element of having cash on hand is being able to take advantage of buying opportunities. I once heard the quote, “The stock market is the only market that when things go on sale, people run out the door.” Meaning, when the stock market has a big pull back (say 30%), instead of buying at a 30% discount, everyone is full of fear and selling. Which, from a long-term perspective, if the market has pulled back say 30%, what a huge opportunity! Consistently buying in at whatever discount the market is offering can make outstanding positive impacts on an overall long-term financial plan. Those clients who had cash on hand were able to take advantage of the market dips and put money to work.
Now, we would never recommend buying into the market during a dip if it meant sacrificing your emergency fund. If your upcoming expenses are covered, your income is set, you have your emergency fund, then it’s safe to begin thinking about buying into a market dip. Having the necessary cash just prepared these clients for when opportunity struck.
What’s the magic number of how much you should keep in your emergency fund? As we often say… it depends. Generally, the textbooks would tell you 3 to 6 months’ worth of expenses. After living through the Coronavirus pandemic, we would now say 6 to 12 months’ worth of expenses. Why? In 2020, we learned that an entire global market can be forced to shut down. We believe last year was an insight into the struggles and the new “war” that the modern world is going to face. Cash is absolute king in times of fear. As I’ve covered, it allows you to cover upcoming bills and potentially be open to buying opportunities. But most importantly, it gives you the mental and emotional peace during times of heightened stress and uncertainty. Plus, having an appropriate amount of cash on hand can likely make you a better investor in the stock market!
The exact amount one should have in an emergency fund varies person to person. We use 6-12 months of expenses as a general guideline. If you’re in a situation if it’s more or less, just think through the pros/cons of having too much or too little sitting in cash and make sure it’s appropriate for you. Above all, this is a topic we’re passionate about and happy to walk through. Let us know if we can help walk through this question of how much cash to have on hand.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Opinions expressed are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice.
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