Henssler Financial recommends that individuals retain a certain amount of liquid assets, at all times, to handle emergencies. This is known as an emergency fund or emergency cash reserves. These assets should be kept liquid and not invested to any sort of growth investment such as stocks or mutual funds.
What is an emergency fund?
As stated above, an emergency fund is an amount of liquid assets that can be used to handle emergencies, should they arise. The fund should be sufficient to handle emergencies so that an individual will not have to borrow money or liquidate investments at an inopportune time. An emergency fund should exclude the expense of income related taxes and contributions to investments or savings. Usually, emergency funds are set aside to cover expenses that arise from an individual’s short-term loss of income because of unemployment, disability, or death of a breadwinner. Emergency funds also can be used to cover unexpected expenses—a new roof for the house, a new transmission for the car, or any other unexpected expense.
In general, a person should maintain the equivalent of three to six months of fixed and variable expenses (excluding income related taxes as well as savings or investments). This guideline is derived from the point of view that if an individual were to lose his or her income because of the loss of a job, the individual will not earn an income and therefore will not pay income taxes. Furthermore, if there is no income, the individual will not be saving or investing.
What investments are appropriate for an emergency fund?
The most appropriate vehicles for an emergency fund are cash and/or cash equivalents, such as checking accounts, savings accounts and money market funds. These assets are low risk and can be readily converted to cash. Short-term certificates of deposits (CDs) are also appropriate vehicles for an emergency fund. We recommend that CDs used for an emergency fund have a maturity date of 90 days or less, and that a portion of the emergency fund be kept in something more liquid that can be accessed immediately with no penalties.
Life insurance cash values can be used as a vehicle for an emergency fund as well. However, these policies may contain delay clauses that will cause the insurance company to delay payment of cash for up to six months. Because emergencies can happen at any time, an individual may be inconvenienced if forced to wait for payment from an insurance policy. We generally do not recommended that life insurance cash values be used for an emergency fund. Likewise, credit cards should not be used for funding emergencies. Credit cards will only increase debt, making financial problems worse.
How much is too much?
An appropriate amount to save is three to six months worth of living expenses. The most conservative approach is to maintain liquidity to cover six months of fixed and variable expenses, however, some situations may warrant more or less. The amount of liquidity an individual keeps on hand in an emergency fund will likely depend on the individual’s comfort level and/or situation. It is important to recognize that, once money is withdrawn from the emergency fund, it should be replaced as soon as possible for future emergencies.
Post 2008 Financial Turmoil
Since the market turmoil in late 2008 until now, many investors either withdrew money from the market or stopped allocating money for investments and placed it into safe assets including cash and cash equivalents. Since unemployment has remained especially high, many have been unwilling to reduce their cash holdings and invest in equities. We feel that stocks have the best potential to grow one’s assets and that those with excess cash reserves should reinvest a portion of their assets in the stock market. If you have been hoarding excess cash and equivalents during the recession and subsequent recovery, consider reevaluating your situation, the amount of necessary emergency reserves, and reinvesting the excess in the market. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
