Life can be unpredictable. Unexpected financial emergencies can set you back whether you're doing well financially or just making ends meet. You might even be tempted to dip into your retirement savings to cover urgent expenses. But Fisher Investments believes that approach risks significant damage to your retirement strategy. The good news: you prepare for the unexpected and help protect your retirement investments by creating a savings buffer with an emergency fund. An emergency fund can give you some peace of mind and reduce the damage from a financial emergency. It can help you cover "emergency" expenses or bolster your budget if you get hit with an interruption to your income.
Think of an emergency fund like a shield
Normally Fisher Investments focuses on long-term investing, but we also provide tools to help folks build a well-rounded financial life. We believe an emergency fund can be an important part of a successful retirement plan. Whatever your income level, an emergency can quickly darken other parts of your financial picture. While we don't think keeping the majority of your savings in cash is a great idea, having cash in an emergency fund can help keep your long-term strategy on track.
An emergency fund can act like a shield, potentially preventing you from selling investments from other vehicles—like a 401(k) or IRA—or getting into debt.
It can be incredibly expensive to tap into these other sources. Say you're 20 years away from retirement and you withdraw $5,000 from a 401(k) to pay for an emergency expense. Over those two decades, your $5,000 could have turned to $13,200 at just a mere 5% annual growth. Additionally, early withdrawals may be subject to income taxes and penalties, further amplifying the impact to your financial situation.
Credit cards aren't a much better option. If you put that same $5,000 on a credit card with an average 19% annual interest rate and made minimum payments of $200 per month, you'd spend about the next 8 years paying back a total of $9,985 in interest and principal.
Importantly, you can gain some peace of mind from the financial breathing room that an emergency fund provides. Fisher Investments knows a financial emergency is almost certain to increase your stress levels, but knowing you can pay for that emergency may help relieve some of your financial anxiety.
And if you already have an emergency fund, but needed to tap into it recently, it's also important to fully restock it so you're ready for life's next curveball.
Fisher Investments' Step-by-Step Instructions to Build an Emergency Fund
1. Set your goal
Many financial experts recommend setting a goal of 3 to 6 months' worth of expenses for your emergency fund. If it's just you, three months' might be enough. If you've got people depending on you, six months' might be better. If you're in retirement and no longer earning a regular income, you might even want to set aside more—maybe up to 12 months' of expenses.
But first, you'll need to determine what that amount is. Fisher Investments suggests you start by totaling your expenses in a typical month. Focus on non-discretionary spending—the things you have to pay regularly: housing, bills, food and such. Then identify budget items you could shed if times got tight. You might even develop a "fallback budget" by determining what services you could cancel if you suffered a financial setback.
2. Put it in the right place
You'll want your emergency fund somewhere safe and easily accessible. A high-yield savings account or a money market account would give you almost instant access to your money
Also, consider an account at an institution that's separate from your primary checking account. Fisher Investments believes this separation could help you avoid the temptation of moving money to your checking account to spend on non-emergency items.
3. Make it a habit
Once you've got an idea of how big your emergency fund needs to be and where you'll put it, it's time to start saving. Find a percentage of your regular take-home pay you can afford to set aside—5% to 10% would be ideal, but whatever your budget can handle is great. You could give your emergency savings a boost from financial windfalls like bonuses, tax refunds or garage sales.
Fisher Investments suggests automating as much as possible to make the saving process easier on yourself. You might be able to set up a rule in your checking account to automatically transfer the 10% to your savings account. This removes conscious thought, and you're less likely to be tempted by money that you didn't really see in the first place.
4. Be patient
Building an emergency fund is going to take some time—maybe even a few years. Don't worry about saving the entire amount overnight. Start with smaller goals to keep yourself focused and motivated. Aim for $1,000 initially. Then $2,000.
Even on the way to your ultimate goal, your emergency fund can still help you avoid taking on expensive debt. Keep that positive saving mindset going even after you finally reach your emergency fund goal. Consider transitioning that 10% to other financial goals like funding an IRA to help boost your retirement savings.
Identifying an "emergency"
Once you're on your way to building an emergency fund, Fisher Investments suggests taking a step back and considering what actually qualifies as an emergency.
A loss of income is definitely a financial emergency whether it's an unexpected early retirement, a job loss or time off to care for a family member. But emergency funds aren't just for income interruptions. For other expenses, look for the three elements that signify a financial emergency:
- Unexpected – something you couldn't see coming.
- Urgent – an expense that needs to be handled right away.
- Unavoidable – a situation where you've got no other choice.
If the situation meets all three criteria, Fisher Investments believes it's probably a good use of your emergency fund. It might be anything from an unexpected vet bill or a medical emergency to car repair after an accident or last-minute travel due to family matters.
Remember, if you have to dip into your emergency fund, restart the saving process to replenish it. That way, it'll be ready when you need it next.
Fisher Investments advises clients on how to invest for the long term. Over a period of 10, 20 or more years, you're likely to face some sort of financial emergency. Building an emergency fund can help lessen the impact on your broader financial picture and keep you moving towards your long-term investing goals.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
