Although a majority of families have some sort of short-term savings for emergencies, these accounts are often utilized as deferred spending accounts. This means they are constantly being drained for impulse purchases and never truly provide the safety of an emergency savings account. Then, when real emergencies arise, debt is often used to cover the expense. This is how many people end up in the downward spiral of debt.
Building your emergency savings begins with effective planning. In order to accumulate enough to cover unexpected events, the money has to come from somewhere. This means trimming areas of your spending for a short period of time and reallocating them to fund your emergency savings. As I stated in previous articles, it is very important to have a written plan to uncover areas of your spending to reallocate to savings.
How much to save?
If you have a written spending plan, you should know exactly how much your monthly expenses are. This makes it very easy to begin building a cash reserve you can use for sudden needs. If you have never maintained this type of savings, start small. Build at least one month’s worth of your expenses in a savings or checking account. There are also various money market vehicles out there that enable you to have instant access to your cash when needed. Some people even feel more comfortable having a portion of their emergency fund held safely at their house in the form of cash for very urgent needs.
Once you have at least one month’s expenses saved, shoot for a goal of three to six months. This gives most people the cushion they need if unemployment or other leave arises. Depending on the amount, you may want to find creative ways to keep your liquidity and maintain your purchasing power. Although there are many effective methods, precious metals are growing in popularity as a store of short-to-intermediate term savings because of their ability to maintain purchasing power in the midst of a declining dollar.
Retirement and your emergency fund
For so many people with low to moderate income, it is a serious challenge to save for retirement and also maintain a safety net. One solution may be to utilize the benefits of a Roth IRA. This investment vehicle allows you to save for your retirement tax-free. One thing, however, that makes the Roth IRA different than other retirement accounts is the ability to access the money you contribute without paying penalties.
Although gains in the account cannot be taken without consequences, your contributions may be taken at any time. This may enable someone to build a retirement account but also have access to emergency funds only if they need them.
One thing to keep in mind is that Roth IRAs by nature will be slightly less liquid than a typical savings account. It may take several days or even weeks to get your funds.
The important thing to remember is that some planning is better than no planning. Have a goal in mind about the type of emergency savings you would like to maintain and stick to it. You can then take most financial emergencies in stride as you prepare for them ahead of time.
— Josh McCleary is an investment advisor representative at Berthel Fisher & Company Financial Services Inc. He can be reached at email@example.com.