Is it important to have an emergency fund? (Transcript)

There’s a lot written out there about how much you should have saved in a rainy day fund. But I want to take a step back and answer the question “Is it even important to have an emergency fund or rainy day fund?” And the answer is a resounding yes!

Now let’s get into the “why” and “how much” you should have in that emergency fund. Quite simply, an emergency fund is the foundation for a strong financial life and a financial plan.  Why is that? Because it is your first line of defense if something unexpected happens. We are wired to hate uncertainty and want to make sure we are insulated from risk. An emergency fund is in a sense another form of insurance against the unexpected. It’s all the foundation that allows you to take risk and invest all the other money knowing you are adequately protected first and foremost.

I always tell clients, let’s say you lose your job, if you have an adequate emergency fund, you don’t have to sell your stocks, raid your 401k or use those high cost credit cards when youre in a pinch and need to look for a job. Those are the types of financial moves that can have dramatic negative ripple affects on the rest of your financial life. You want to prevent one unexpected event from having all these additional impacts on your financial life. That’s the purpose of an emergency fund and why it makes dealing with the harder times a little bit easier. With an emergency fund you can think of it as your risks being contained.

So this all makes common sense, right? So how much should you have saved in your emergency fund? The rule of thumb is three to six months of your monthly expenses. The amount is usually correlated with how much security you have in your financial life. So if you have a lot job security and diverse sources of income or a large amount of assets, you probably need less than someone who has a lot of more insecurity or volatility like someone who is self employed and doesn’t know where their next paycheck is going to come from.

Emergency Fund = Peace of Mind

Ultimately, the right amount in your emergency fund is the amount that lets you sleep well at night. Sure it might be too much at times, but who cares if it means you’re not feeling stressed? The point is really put you at ease. [Check out this related article here.]

Finally, where do you put the money for your emergency fund? Always somewhere safe and accessible. Not in your mattress! But in a savings account, a money market account or other types of short term bonds like Treasuries that really aren’t going to move a lot in value. And that are easily accessible. You won’t earn a lot of money on your emergency fund. And that’s not the point. You are not going to get rich or be made rich by this emergency fund. Its only there for your protection.

Those are my quick thoughts on an emergency fund. As always if you have any other questions visit my website: thinkingbigfinancial.com for any questions you might have about financial planning or investment management. Take Care.