Life is full of surprises, and not all of them are pleasant. Imagine facing a sudden job loss, a car accident, or an unexpected hospital visit. How quickly would financial worries overshadow the initial shock of such events?
According to a recent survey by Bankrate only 3 in 10 Americans could cover an emergency expense from their savings. This stark reality underscores the importance of having an emergency fund—a financial safety net that can help you navigate trying times without derailing your long-term money goals.
Assessing your financial needs
Building an emergency fund starts with understanding your monthly living expenses. This can be a daunting task, as expenses span various categories such as foodhousingtransportation and medical costs.
When you set up an Emergency Fund goal with Betterment the platform automatically estimates your monthly expenses based on two key factors: your self-reported household annual income and the estimated cost of living in your zip code. While you can use your own figures, the goal is to get started without getting bogged down by complex calculations.
Determining your emergency fund target
Financial experts generally recommend saving at least three months’ worth of expenses in your emergency fund. However, your personal circumstances may warrant a larger cushion. Consider saving more if you:
- Support others financially
- Have an unstable job
- Experience irregular income
- Have a serious medical condition
Ultimately, the ideal amount is what gives you peace of mind. Nearly ⅔ of people surveyed by Bankrate believe that six months or more of expenses is the sweet spot.
Betterment can help you reach your target by suggesting a monthly recurring deposit and projecting a four-year balance based on your initial and scheduled deposits, as well as expected returns and volatility. This timeframe is considered realistic for saving at least three months of living expenses through consistent contributions.
Choosing the right home for your emergency fund
Once you’ve determined your target amount, it’s time to decide where to keep your emergency fund. There are two primary options: a low-risk, high-yield cash account or a bond-heavy investing account.
A cash account such as Betterment’s Cash Reserve offers the advantage of no market risk, although it may not keep pace with inflation. Cash Reserve is offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank, and FDIC insurance is provided by Program Banks, subject to certain conditions.
An investing account can help your emergency fund keep up with inflation but comes with relatively more risk. To account for potential market fluctuations, Betterment suggests adding a 30% buffer to your target amount if you opt for the default stock/bond allocation. Additionally, there may be tax implications when withdrawing funds.
Your choice will depend on your comfort level with risk. If market volatility causes you anxiety, a cash account may be the better choice. Alternatively, you can split your emergency fund between the two options to hedge your bets.
Remember, your emergency fund is not a set-it-and-forget-it endeavor. Life circumstances change, and so will your financial needs. Revisit your numbers periodically—such as after a raise or a significant new expense—and adjust your savings accordingly. By maintaining a robust emergency fund, you’ll be well-equipped to handle life’s unexpected challenges and Achieve financial peace of mind.
