By Michaela Scott
At some point, everyone will experience a financial emergency. Whether a hospital visit, job loss or getting stranded away from home – all of which happened to millions of Americans due to the COVID-19 pandemic. An emergency can always lurk around the corner, and, when it hits, it may require a substantial expenditure to address.
This ever-present risk clearly demonstrates the need for an emergency fund to set the foundation of any financial house. Properly established and maintained, emergency funds provide fiscal and emotional security against the involuntary dangers of life – but too many Americans neglect this aspect of personal finance.
Especially following the economic devastation brought about by 2020, financial advisors will need to devote extra attention to this piece of every client’s portfolio.
For the average, middle-class American, an emergency fund should contain between three and six months’ worth of expenses. Americans in two-income households can more safely err toward three months’, though the risk is still higher with that arrangement.
Keep in mind that the calculated expenses must include not only already-existing costs like housing and food, but also costs that only kick in during periods of unemployment, namely COBRA health insurance.
Emergency savings need not cover every current expense, though. Entertainment and recreation should not be entirely forsaken when clients are out of a job, since a fiscal emergency can get much worse if a client’s mental health deteriorates too. But premium or ad-free versions of streaming services, delivery apps or games can be cancelled until clients restore regular income streams.
Some clients may struggle with maintaining emergency savings because they’re not seen as “smart” money. Clients, especially young clients who prize financial independence, may be more inclined to pour extra income into the markets.
But the point of an emergency fund kept in a standard savings account (preferably a high-interest one) is to keep that money safe and accessible. This both protects the funds from market swings and ensures they won’t take three days to transfer into a cash account if needed.
Use And Recovery
Job loss is the scenario most people have in mind for their emergency savings, but there are other reasons to break open the ultimate piggy bank. Healthcare costs are exorbitant, and any trip to the hospital could necessitate dipping into savings. So, too, could smaller things, like buying holiday gifts for children while unemployed. On the other hand, foreseeable and reasonable costs like car repairs, home upkeep and predictable medical needs should ideally be budgeted for outside an emergency fund.
After the unforeseen job losses and healthcare costs of 2020, many advisors will spend 2021 helping clients rebuild emergency savings accounts. Aside from cutting back on luxury spending, clients will have to make other hard decisions until emergency reserves are rebuilt.
For example, consider putting a hiatus on saving for a child’s education or postponing any optional support of paying down student debts. While taking on additional debts when rebuilding an emergency reserves is not advisable, looking to refinance, especially now, is a great exploratory exercise.
Furthermore, tactics like threatening to cancel a cable plan can also yield some savings through reduced monthly bills. Clients should even consider reducing retirement contributions to their employer’s match level until their emergency funds are fully revitalized.
Theoretically, anyone is capable of achieving financial independence with or without help from others. In practice, many Americans depend on their employer incentivizing good financial decision-making. Just as employers auto-deduct from employee paychecks for retirement savings, HSAs, insurance premiums and even public transit allowances, so too can employers create auto-enrolled emergency savings accounts for their employees.
Beyond the obvious benefits to their employees, employers would themselves benefit from a more productive, less stressed and financially healthier workforce. The need for financial workarounds like paycheck advances would decline, and employers who sign on would have another workplace benefit to tout over their competitors.
Emergency funds can end up neglected or forgotten until the very moment a client needs one. But with the lessons of 2020 in mind, financial advisors should remind all clients of the fundamental importance of planning for the days we hope never come to pass. With the necessary emergency savings tucked away, clients can walk through life a little less stressed, and a little more secure.
About The Author
Michaela Scott, CFP®, MSFS, leads Borislow’s Employer Retirement Consulting Practice, which offers advisory services through Royal Alliance Associate, Inc. (RAA), member FINRA/SIPC, and not affiliated. She has been an MDRT member for six years. Michaela earned her Master of Science in Financial Services with a concentration in Retirement Planning from the American College of Financial Services. She is also a Retirement Income Certified Professional. Michaela co-authored If I Had Only Known – Checklist and Guidance for Before and After Death with Jennifer Borislow and Melissa Marrama. Michaela lives in Hampton, New Hampshire. 978-722-1104, Borislow Insurance, One Griffin Brook Drive, Methuen, MA 01844.