Many people would agree that preparation is the key to success in many areas of life.
Yet, when it comes to being ready for a financial emergency, a sizable percentage of Americans are feeling distinctly unprepared — and that can lead to problems.
Consider these survey findings from financial services provider Edward Jones and Morning Consult:
Nearly two in five Americans expect that their emergency savings would last no more than a month.
Less than 40 percent of respondents consider their emergency savings account to be fully funded.
It’s important to have adequate emergency savings for two key reasons.
First, when an unexpected financial need arises, such as a major home or car repair, you may well have to act quickly.
And second, if you don’t have the funds readily available to meet this sudden need, you may be forced to dip into your long-term investments, including your IRA and 401(k).
This typically isn’t a good move, as taking money early from these accounts could lead to both taxes and penalties.
And even more important, you’d be taking away resources from accounts you will almost certainly need to help provide income for a retirement that could last two, or even three, decades.
So, if you want to be financially prepared for emergencies, how much money should you have available?
There’s no one right answer for everyone, but generally speaking, it’s a good idea to keep three to six months’ worth of living expenses — or a full year’s worth, if you’re retired — in a liquid, low-risk account that’s separate from the financial accounts you might use for everyday spending.
Of course, given the high cost of living, it’s not necessarily easy to put away several months of living expenses — at least, not all at once.
That’s why you might want to have a certain amount automatically moved each month from your checking or savings account into the account you’ve designated for emergency needs.
And when you get a financial “windfall,” such as a year-end bonus at work or a tax refund, you might want to use part of this money for your emergency fund, too.
You can also use these sources to replenish your emergency fund if you deplete some or all of it.
Here's something else to remember about an emergency fund:
Keep it for emergencies. As mentioned above, you should hold this fund apart from accounts that you draw on for daily expenses — but you’ll also want to avoid the temptation to use the money for other things, such as investment opportunities that may come your way.
That’s not to say you shouldn’t be prepared for these opportunities, but you can do so by keeping some cash or cash equivalents within your portfolio.
And, as an additional benefit, the presence of cash can potentially help reduce the impact of market volatility on a portfolio that’s otherwise heavily weighted toward stocks.
Building and maintaining an emergency fund should be an essential part of your overall financial strategy — so, if you haven’t started one yet, there’s no time like the present.
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