How Your Emergency Fund Helps You Bounce Back
By Gary Silverman, CFP®
Remember, we are in the midst of talking about savings (emergency, shorter-term, and longer term) as part of our discussion on preparing for the next financial crisis. As such, we won’t be going into too much more detail about savings other than this: It’s your cushion.
The emergency fund is obvious. It exists specifically for a financial crisis. Yet it is normally kept at a level for a “normal” crisis: Smashing up your car, coming home to find water pouring out your front door, or the ramifications of a frank talk with your doctor. In all three, it is a combination of savings and insurance that covers the emergencies. (Dear Bill Gates, you probably don’t need the insurance part.)
One emergency that is a little more troublesome is loss of a job. Here is where we could easily get past what your emergency fund will handle. Given that both the Financial Crisis of 2008 and the COVID crisis of now has resulted in longer bouts of unemployment than most would plan for, you need to be ready for this “in case.”
So, in general, look at your short-term and longer-term savings and imagine you were out of work for the next 6 months. Decide, in order, what would you start spending down. Part of this decision is based on what the effects of that spend down are.
If you’ve got $3000 saved up for next year’s vacation, then that’s an easy pot of money to go after. You want a vacation, but there is no real issue with not taking it…you don’t need it...at least not compared to rent and food.
The savings for your next car is a little more problematic. You want a car and eventually you will need a car. Spending that money may put you into another crisis later on when your current vehicle dies. This is the same for savings for appliance replacements or home repairs. You don’t know exactly when they will happen, but they will happen.
When it comes to longer-term savings, such as that for retirement or college, we get into some interesting decisions. Since often you are using tax-deferred accounts for retirement savings, you need to consider what you lose tax-wise by pulling money out for current spending. When the crisis is over, you should examine how far behind that placed you, and adjust accordingly. You may have to work longer, save more, or adjust your post-work budget (or likely a combo of the three).
While college is a definite advantage for your kids, it’s not a need; therefore, you should plan on discussing alternatives with them. This may include letting your kids know that the more expensive schools might be off the table, or that they might need to start out at a community college (which can be advantageous for many other reasons), and that they may have to accept more of the financial burden through work or student loans.
Finally, notice, that all of this, while not pleasant, is at least possible because you have a savings program to address these things. Without it, your crisis will be a lot worse.
Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing.