As we embark on the last article in the three-part series, I want to cover what emergency savings are good for and what they aren’t. There are hundreds of benefits to emergency savings. A few examples are:
- Helps you sleep at night
- Lowers stress levels
- Encourages more diligent spending
- Manifests in better financial decision making
- Covers unexpected events
- Functions as a pseudo-insurance policy
- Enables you to redirect attention to key decision points
- Provides a measure of financial freedom
You’d likely be hard-pressed to find someone who would argue that an emergency savings account is of no benefit whatsoever, that we’re all foolish for having them, and that it’s better to live life right on the edge of a financial cliff—one simple accident away from significant debt or bankruptcy. If you can earmark money now to help offset some of the turmoil of an emergency, you’ll be completely fine, right?
Well, the harsh truth is it depends. What I mean by that is that there are only about 3,000 people on this planet (think billionaires) who could consider themselves completely prepared for any possible emergency, no matter the cost. We could possibly extend that to millionaires, in which case the few thousand people becomes 47 million people. As a point of reference, that’s 0.6% of the total population of Earth. The rest of us are left with some amount of uncertainty about whether we’ll be able to cover ourselves financially in the event of an emergency.
But let’s assume you follow the widely-accepted gold standard of saving three to six months of living expenses in your emergency fund. This is decent advice, and once you’ve got that much in your account, you will be covered for most scenarios. Notice I said most scenarios, not all scenarios—this is the crux of my argument, and it’s also where smart people get fooled into thinking they’re completely safe from financial harm. That assumption of being covered for all possible outcomes is not true, and that’s largely why we’re seeing, on average, three in five people emptying their emergency savings funds by the end of 2020. I’d be willing to bet 95% of those folks also thought they’d be safe from every possible emergent scenario.
So, the question is—what is your expectation for your emergency savings? Do you expect it will cover you in 99% of all possible outcomes? Maybe 75%? Perhaps 50%? The percentage isn’t as important as being prepared, and it takes a multi-layered strategy to be truly prepared.
Let’s start with the simple definition of strategy: a plan of action or policy designed to achieve an overall aim. And we all know any worthwhile strategy has multiple facets to it—if Option A does not materialize, we need to have an Option B, Option C, and so on. If we were to visualize how this might look, I would compare it to a funnel-shaped filter. Each layer has its own function, and all layers have the same goal of protecting you from catastrophic loss or financial turmoil as a result of an emergency situation. Each layer has a finer and finer grain such that more is filtered out the deeper into the funnel you go. As with most advice I provide on this site, your funnel should be tailored to your specific of risk and personal financial situation. The layers may be ordered differently or may be bigger or smaller, but the principle of having a multi-layered strategy is critical to surviving an emergency.
Next, we’ll talk about each of the layers.
- At the top is the first layer of your emergency strategy—the emergency fund. This is where you’ve accumulated some amount of cash, as determined by what level of risk you’re willing to accept. If you’re relatively certain you won’t need it, maybe you keep three months of expenses in this account. If you think there’s a good chance you need it someday or you’re willing to accept less risk, perhaps you shoot for six to nine months of expenses on hand. Given all that’s going on in the world now, twelve months is likely a better goal. If you choose to invest this money, it should be in an account that’s liquid and you could get to quickly if needed. Maybe that’s an interest-bearing savings account or money market account. Interest rates are very low now, but at least you could earn a small return with relatively little risk. I would strongly advise against investing in stocks, mutual funds, or other less-than-liquid investments as the returns are volatile and your emergency fund could be wiped out overnight.
- The next layer could be a plan to scale back on spending, although this should be executed at the point where you need to tap into the first layer (emergency savings). In part two of this series, I discussed strategies to pare back on expenses, and there is a number of other articles on the site that do the same. If you plan accordingly, you can enact these strategies quickly and successfully, if needed, thereby minimizing your risk exposure.
- Next would be adequate insurance. Let me state that I’m not a big fan of overreliance on insurance because I believe there is such a thing as paying too much for too little coverage. In this layer would reside health insurance, disability insurance (preferably short- and long-term if you can afford it), life insurance, and the like. Once you’ve exhausted emergency savings and reduced spending as much as possible, you’ll be relying on a fixed income stream from an insurance policy. This can be a precarious spot to live if you have minimal coverage.
- The following layer could be a familial or social network. If things become dire within your financial world, it is crucial to have family and/or friends who would be willing and able to help you in an emergency. Maybe they could offer financial assistance, help buying food, or maybe even offer you a place to live until you get back on your feet. For some folks, this may not be an option; in that case, we move onto the next layer of the filter.
- Government assistance is a safety net for a significant portion of our population—and more folks are joining these ranks every day. This layer includes social programs like SNAP (Supplemental Nutrition Assistance Program), WIC (SNAP but focused on Women, Infants, and Children), unemployment, Medicaid, CHIP (Children’s Health Insurance Program), TANF (Welfare or Temporary Assistance for Needy Families), SSI (Supplemental Security Income), subsidized housing, housing vouchers, public housing, etc. These are all critical to the safety and welfare of folks in our country and meet many needs that would otherwise go unmet. If you make it to this layer, take time to educate yourself on the options available to your situation. Each of these programs has its own set of eligibility criteria and application process, so be aware of that when determining what is right for you. This is, by no means, an exhaustive list of options available but is a good start toward finding a program you might need.
Through a multi-layered filter approach, you are much better protected from financial chaos. The strength of the strategy lies in the successive ability to filter out certain types of scenarios. If the first layer fails, you go onto the second, and the third, and so on. Very few scenarios would make it all the way through this filter and beyond, although it’s never impossible for that to happen. Employing a financial emergency strategy will give you peace of mind to know that you will be covered for many of life’s challenging situations. And peace of