As we noted in our last entry, lack of an adequate emergency fund can result in excessive use of credit cards and the associated high-interest-rate debt. Having an adequate stash of cash on hand can prevent personal financial disasters.

 

Financial planners typically recommend that an emergency fund equal to three to six months of fixed and variable living expenses be maintained in liquid assets (cash or cash equivalents).  This is to avoid having to liquidate investments at a possible loss as a result of an emergency. 

 

An adequate emergency fund for many will easily top $10,000 to $ 20,000 or more depending on your situation.  Often, we are amazed to see that clients have placed their emergency fund in a bank savings account earning a fraction of a percent in annual interest.  With a little effort you should be able to find safe money market or money-market-like fund that pays two to three times what most bank savings accounts pay.

 

The exact amount of emergency funds you should have can vary based on your personal situation. An emergency fund of three months may be sufficient for families with both spouses earning a solid income with good job security or retirees with guaranteed pension and social security income.  On the other hand, if you’re either unmarried or married and only one spouse works, or job security is an issue, then it’s important to have at least six months of living expenses socked away.   People with highly variable income stream (such as sales people whose earnings primarily consist of sales commissions), should allocate even more.  Individuals working in highly volatile or cyclical industries should also set aside more in their emergency funds.  In some cases, we would recommend an emergency fund equal to a full year’s needs.  If you’re unsure of how much to put aside, err on the high side.  We’ll talk some more about emergency funds in our next entry.