The Henssler
Financial Group recommends that individuals retain a certain amount of liquid
assets, at all times, to handle emergencies. This is known as an emergency fund
or emergency cash reserves. These assets should be kept liquid and not invested
to any sort of growth investment such as stocks or mutual funds.
What
is an emergency fund?
As stated
above, an emergency fund is an amount of liquid assets that can be used to handle
emergencies, should they arise. The fund should be sufficient to handle emergencies
so that an individual will not have to borrow money or liquidate investments at
an inopportune time. An emergency fund should exclude the expense of income related
taxes and contributions to investments or savings. Usually, emergency funds are
set aside to cover expenses that arise from an individual's short-term loss of
income because of unemployment, disability, or death of a breadwinner. Emergency
funds also can be used to cover unexpected expenses — a new roof for the
house, a new transmission for the car, or any other unexpected expense.
In
general, a person should maintain the equivalent of three to six months of fixed
and variable expenses (excluding income related taxes as well as savings or investments).
This guideline is derived from the point of view that if an individual were to
lose his or her income because of the loss of a job, the individual will not earn
an income and therefore will not pay income taxes. Furthermore, if there is no
income, the individual will not be saving or investing.
What
investments are appropriate for an emergency fund?
The
most appropriate vehicles for an emergency fund are cash and/or cash equivalents,
such as checking accounts, savings accounts and money market funds. These assets
are low risk and can be readily converted to cash. Short-term certificates of
deposits (CDs) are also appropriate vehicles for an emergency fund. We recommend
that CDs used for an emergency fund have a maturity date of 90 days or less, and
that a portion of the emergency fund be kept in something more liquid that can
be accessed immediately with no penalties.
Life
insurance cash values can be used as a vehicle for an emergency fund as well.
However, these policies may contain delay clauses that will cause the insurance
company to delay payment of cash for up to six months. Because emergencies can
happen at any time, an individual may be inconvenienced if forced to wait for
payment from an insurance policy. We generally do not recommended that life insurance
cash values be used for an emergency fund. Likewise, credit cards should not be
used for funding emergencies. Credit cards will only increase debt, making financial
problems worse.
How much is too
much?
An appropriate amount to save
is three to six months worth of living expenses. The most conservative approach
is to maintain liquidity to cover six months of fixed and variable expenses, however,
some situations may warrant more or less. The amount of liquidity an individual
keeps on hand in an emergency fund will likely depend on the individual's comfort
level and/or situation. It is important to recognize that, once money is withdrawn
from the emergency fund, it should be replaced as soon as possible for future
emergencies. For more information regarding this topic, please contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.
