Everyone has a plan, until they get punched in the mouth.
-Mike Tyson, former Undisputed Heavyweight Champion of the World
The reality is we all have plans, but life provides figurative (and sometimes quite literal), precise blows to our financial future. Life happens, can’t avoid, it but we must understand an emergency savings is essential to securing our finances.
For most of the population, an emergency savings is thought as a luxury. In fact a 2019 Forbes article noted 78% of the population lives paycheck to paycheck and less than 44% of full-time workers save more than $100 per month. Those are sobering numbers. If you don’t think you need an emergency savings, then I’ll pose the following question to you:
If you were to lose your job today, could you maintain your lifestyle for one month? How about 2 months? 3 months?
If you answered yes to those questions, then most likely the rest of this article won’t benefit you. However if you answered no, then I suggest reading on.
How to calculate your emergency savings?
Personal finance is just that, personal. There is no one size fits all version. This applies to emergency savings as well. The rule of thumb is 2-3 months worth of your after-tax income is out of date and out of touch. If you don’t believe me, lets look at the following two scenarios:
| Scenario 1 | Scenario 2 | |
| Age | 28 | 28 |
| Marital Status | Single | Single |
| Occupation | Administrative Assistant | Pharmacist |
| Monthly Income | $3,200.00 | $7,300.00 |
| Monthly Expenses | $2,080.00 | $4,745.00 |
| Emergency Savings Goal | $9,600.00 | $21,900.00 |
| Estimated time to reach goal | 15 months | 15 months |
Both scenarios have monthly expenses equal to 65% of after-tax monthly income.
Estimated savings rate of: 20% of monthly income.
Now consider this, the person in scenario one works as an administrative assistant, if this person were suddenly laid off, there is a considerable risk in the amount of time needed to secure gainful employment. Having an emergency savings which could secure more than 3 months of income, would lower that risk. Anything less than 3 months would add undue stress and panic.
The person in scenario two has a critical skill and with that comes job security. If they were laid off, that skill would allow for a rapid re-entry back into the work force. In this scenario having an emergency savings of three months might be overkill. An emergency savings of 1-2 months might be more appropriate, and the additional money could be used to generate passive income.
Take an individualized approach to your Emergency savings goal. Set your goal by estimating the number of months you’ll need to find gainful employment in your chosen field then multiply by your current monthly (after-tax) income.
Our scenarios utilize a monthly savings rate of 20%. Some folks would say that’s an aggressive rate, others would say it’s to low. The reality is you need to save with a goal in mind, and work every month towards reaching that goal. The faster you achieve the goal, the quicker you can move on to something else. No matter what you choose, just start saving.
Below are some of our favorites accounts for the purpose of building an emergency fund.
High Yield Savings Account (HYSA)
According to Investopedia, a High Yield savings account pays an interest rate at 25 times the national average. That might not seem like a lot, but if your emergency savings goal is $9600 and you don’t touch it for 3 years, with the help of compound interest, you’ll have an ending balance of $10,112. That’s $512 dollars of free money!! Who wouldn’t want that?
There are downsides to HYSAs however. Many of these accounts are housed at digital banks, so if you prefer a brick and mortar financial institution, these accounts may not be for you. Additionally there are transaction limits, so if you require constant access or quick transfer of funds this account may not be for you.
Money Market Accounts
Money market accounts (MMA) have similar in feature to HYSAs, however with a few caveats. These accounts may require higher initial deposits and a minimum balance to maintain your desired interest rate. However these accounts receive an associated checkbook you can use to readily access your funds.
Remember, you need ready access to money in an emergency, thus, your money should be kept in a safe, low risk, interest bearing account which you can access in a pinch. If you’re okay with increased risk, you can also use a standard taxable brokerage account to stash your emergency funds. However depending on market conditions, you may run the risk of losing a substantial amount of money should you need to liquidate your holdings.
If you’re interested in obtaining a HYSA or MMA, make sure to check with your local credit union or your current bank to check their current rates. Also you can research the best interest rates available on sites such as Nerdwallet, Investopedia, who keep up to date information on the current rates and offerings of different financial institutions.
-Mike Tyson, former Undisputed Heavyweight Champion of the World
As always if you have questions or concerns regarding creating an emergency fund, investing, real estate, insurance, or planning for the future, don’t be afraid to speak with qualified financial advisor. Smart Asset has a great tool to find an advisor in your area or feel free to email me (contact@surgifi.com) to help you on your path to financial independence.
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[…] If COVID-19 has taught us anything, it’s the fact that not all of us are essential, and most of us don’t have enough money tucked away for a rainy day.An adequately funded, emergency savings account is essential to maintaining a strong secure financial future. This is not debatable in our opinion. An emergency savings may come in many forms, however our favorite is cash deposited in a high-yield savings account, but the key is: YOU NEED ONE. If you need a refresher on how to build an emergency fund check out our earlier work. […]