You know you need to invest some of your income in stocks, bonds and funds of both, and you do. Yet can you feel safe when Wall Street yo-yos a couple hundred points a day? How much cash do you need at the ready?
Most financial advisors agree that first you need an emergency fund of some six months’ expenses – and more in a down economy. Such emergencies generally mean a job loss or other disruption in your income or a blindsiding expense. This fund helps you pay such bills as your mortgage, utilities and groceries – and you may need more than six months’ expenses if your household relies on one income or you lose a job that’s hard for you to replace.
“This account should only be used in case of emergency,” says Dan Crimmins of Crimmins Wealth Management in Woodcliff Lake, N.J. “We recommend that other expenses such as a vacation or additional household expenses be saved for separately.”
If you haven’t saved this much yet, you’re not alone. Almost one in three Americans have no money put aside for emergencies, according to a recent Bankrate survey. About one in five people sock away enough to cover less than three months of expenses.
To boot, fewer than half of American households can replace a month of income through liquid savings, according to the Pew Charitable Trusts. Low-income families typically have less than two weeks’ income in checking and savings accounts and cash.
The ideal size of your fund depends on such factors as the number of incomes in your household, your earnings from such sources as pensions or investments, your job security, your access to a home equity line of credit and your overall cost of living, according to Sterling Raskie of Blankenship Financial in New Berlin, Ill.
“I like to have an additional six months’ cash set aside,” he says. “Usually, this gives a year buffer not only for emergencies but also for unexpected household items such as a new water heater, roof, vehicle repairs and so on.”
Usefulness of these savings hinges on how fast you can get to the money. The two most familiar accounts to hold liquid funds are savings/checking accounts and brokerage money market accounts. Most Americans use the former, along with credit union accounts, to save, according to Americasaves.org, and auto-deduct savings right from a paycheck.
Though the Federal Deposit Insurance Corp. (FDIC) insures your savings up to $250,000, a general savings or checking account pays about 0.10% to 0.25% yearly. Your other major choice is a money market account from a bank, discount brokerage house or other financial institution. These accounts are liquid and stable – usually invested in bonds and other low-yielding paper. Money markets also pay dismal interest, usually around 1% or less.
“Not going to make much,” Raskie says, “but it’s not supposed to. It’s for liquidity.”
Online savings banks tend to pay slightly more interest than the big banks, but also frequently trim their touted higher introductory interest rates after a few months.
Putting your disaster money in an aggressive stock mutual fund may net you better returns, but your safety net for a dire situation can also shrivel in a market crash or correction – leaving you with little of the money you originally earmarked to fund the account.
One thing's for sure when it comes market volatility and your emergency fund: ignore the noise over in your brokerage account, experts advise.