Establishing an Emergency Fund: A Guide for Young Families

As a financial adviser in San Diego, I frequently encounter young families who are eager to secure their financial future but often overlook a crucial component of financial stability: the emergency fund. Establishing an emergency fund is a fundamental step in financial planning, providing a safety net for unexpected expenses and helping to avoid debt. This article will guide you through the process of setting up an emergency fund, determining how much you should save, and choosing the best type of account for your emergency fund.

What is an Emergency Fund?

An emergency fund is a stash of money (cash usually) set aside to cover financial surprises, most common are job loss or medical emergencies, car repairs and sudden home repairs are common as well. The primary purpose of an emergency fund is to provide a financial cushion that can help you avoid high-interest debt, such as credit card debt or personal loans, during times of unexpected financial hardship or from having to sell out of your investments which could trigger an unwanted tax bill. An emergency fund is generally best set up as a “separate don’t touch” savings account you could access quickly, not cash that’s commingled with your checking account.

Why Do You Need an Emergency Fund?

Life is unpredictable, and financial surprises can occur at any moment. Without an emergency fund, you might find yourself scrambling for money in a crisis, potentially turning to credit cards or loans that can lead to significant debt. An emergency fund ensures you have the financial means to handle these situations with less stress, maintaining your family's stability and peace of mind.

How Much Should You Save?

The amount you should save in your emergency fund depends on your household's specific circumstances. As a general rule, financial experts recommend saving three to six months' worth of living expenses. However, the exact amount can vary based on whether you are a single earner or a dual earner household.

Single Earner Household

If your household relies on a single income, it's advisable to save closer to six months' worth of living expenses. This is because the risk is higher; if the primary earner loses their job, the family loses its main source of income. Having six months' worth of expenses saved can provide a more substantial buffer while the primary earner searches for new employment.

Dual Earner Household

For households with two incomes, three to six months of living expenses might suffice. The dual income provides a bit more security since it’s less likely that both earners will lose their jobs simultaneously. Therefore, a minimum of three months' expenses might be adequate, but aiming for six months can still offer added security and peace of mind.

How to Calculate Your Emergency Fund

To determine the amount you need, follow these steps:

1. List Essential Monthly Expenses: Include rent or mortgage payments, utilities, groceries, transportation, insurance, and any other necessary living expenses.

2. Calculate Total Monthly Expenses: Add up all your essential monthly expenses to get your total monthly cost of living.

3. Multiply by 3 to 6 Months: Multiply your total monthly expenses by the number of months you want your emergency fund to cover (3 to 6 months).

For example, if your essential monthly expenses total $3,000, you should aim to save between $9,000 (3 months) and $18,000 (6 months).

4. Other Important Factors to Consider:

• Your own emotions: If a larger emergency fund helps you sleep better at night, don’t ignore it. However, ensure any fears/desires for a larger fund are based on realistic concerns

• Your Industry: For your industry, how long would it take you to find a new job? Not all industries are the same. Some, like tech, this can swing wildly based on current job market.

Best Accounts for an Emergency Fund

When choosing where to keep your emergency fund, accessibility and safety are key factors. Here are a few types of accounts that are ideal for emergency funds:

1. High-Yield Savings Account: This is one of the best options for an emergency fund. High-yield savings accounts offer better interest rates than traditional savings accounts, allowing your money to grow while still being easily accessible.

2. Money Market Accounts: These accounts typically offer higher interest rates than regular savings accounts and often come with check-writing privileges. However, they might require a higher minimum balance. Some invest their emergency fund in a fund like “Schwab Value Advantage Money Fund” (SWVXX), just be mindful this fund does have a 0.34% expense ratio that should be accounted for.

3. Certificates of Deposit (CDs): While CDs offer higher interest rates, they are less liquid than savings or money market accounts. If you opt for CDs, consider laddering them (e.g., having a 3-month, 6-month, and 12-month CD) to ensure you have periodic access to funds.

4. Online Banks: Many online banks offer high-yield savings accounts with competitive interest rates and no minimum balance requirements. They also provide easy online access to your funds.

Steps to Establish Your Emergency Fund

1. Set a Savings Goal: Based on your calculation of essential expenses, set a target amount for your emergency fund.

2. Create a Budget: Adjust your budget to include regular contributions to your emergency fund. Even small, consistent deposits can add up over time.

3. Automate Savings: Set up automatic transfers from your checking account to your emergency fund account. Automating savings ensures that you consistently contribute to your fund without having to think about it.

4. Reduce Non-Essential Spending: Identify areas where you can cut back on non-essential expenses and redirect that money into your emergency fund.

5. Use Windfalls Wisely: Use any unexpected income, such as tax refunds, bonuses, or gifts, to boost your emergency fund.

6. Stay Disciplined: Avoid dipping into your emergency fund for non-emergencies. Keep the purpose of this fund clear and only use it for true financial emergencies.

Maintaining and Growing Your Emergency Fund

Once you've reached your savings goal, continue to monitor and adjust your emergency fund as necessary. As your living expenses change (e.g., having another child or moving to a more expensive area), you may need to increase the amount in your fund. Periodically review your budget and make adjustments to ensure your emergency fund remains adequate.

Conclusion

Establishing an emergency fund is a critical step toward financial security for young families. By understanding how much to save, choosing the right type of account, and committing to regular contributions, you can build a solid financial safety net. As a financial adviser in San Diego, I recommend starting today to ensure your family is prepared for whatever financial surprises life may bring.

Creating and maintaining an emergency fund not only provides financial stability but also peace of mind, knowing that you can handle unexpected expenses without derailing your long-term financial goals. If you need personalized advice or assistance in setting up your emergency fund, don't hesitate to reach out to a financial adviser in San Diego who can guide you through the process tailored to your specific needs.