How’s Your Emergency Fund?

Financial planners commonly recommend you keep an easily accessible emergency fund for unexpected expenses. Too bad few people do it. Take steps now to avoid being caught short of money.

More than a third (34%) of 2,000 adults recently had an unexpected event such as a medical problem or a home-related expense that set them back financially, according to a national survey by Pew Research.

Unfortunately, additional research shows that we’re just not saving enough. A study by Bankrate reveals that 42% of Americans can’t cover three months of expenses and only 28% can cover six months or longer.

Almost half – 45% – of respondents earning more than $75,000 per year report a backup fund of at least six months’ expenses. Among those earning less than $30,000 annually, 52% maintain no rainy-day fund.

Emergency funds provide you with a safety net and cover expenses until you get your fiscal house back in order. Though most agree these funds are necessary, no real consensus exists regarding the appropriate amount.

Many factors influence the size of your fund: the number of incomes in your household; your earnings from other sources such as pensions or investments; your access to a home equity line of credit (which can fluctuate with your local housing market) and your overall cost of living.

It’s also common to underestimate expenses or only consider fixed expenses such as a mortgage or car payments. Families need to examine their entire budget to estimate how much they need for the unexpected.

First, while we agree with the optimism about the economy and financial markets going forward, many families remain wary from the 2008 financial crisis and concerned about job security. Average unemployment currently lasts some 31 weeks; those jobless individuals tend to live on credit to replace income – only highlighting the importance of maintaining a reserve fund.

A fund of nine months to one year of expenses is good for most families. The best approach: Customize your fund’s size to your own circumstances and in consultation with your financial advisor. Start saving whatever you can now.

Yes, finding spare cash after contributing to your 401(k) and individual retirement accounts (not to mention college funds or other savings) can be challenging. Start with small amounts, perhaps your next tax refunds, and make systematic contributions; look for discretionary expenses you can reduce, such as taking a cheaper vacation or eating out less.

I work with many clients who express frustration with the lack of growth in an emergency fund. Short-term interest rates are below 1% for four years now and the Federal Open Market Committee of the Federal Reserve looks to preserve that low rate for a while longer. With our firm’s recommended 70% stock/30% bond allocation – returning more than 14% in 2012 and bonds returning about only 4% – families are tempted to invest reserves in a strategy that may provide higher returns.

Resist playing Monday morning quarterback, lamenting what you lost not pursuing big returns over the past few years. Remember the primary purpose of an emergency fund: security. We recommend holding your emergency funds ready in a savings or money market account at an institution with Federal Deposit Insurance Corp. (FDIC) insurance.

Emergencies don’t happen when you expect. Make sure the money is there when you need it.

Follow AdviceIQ on Twitter at @adviceiq

Written by Wayne A. Lippert Jr., CFP, who is a wealth advisor and principal at Truepoint Wealth Counsel in Cincinnati.

AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.