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You have probably heard how important it is to have an emergency fund in case of, well, emergencies, especially after divorce when you are out on your own. Conventional wisdom says that your savings should be able to cover about three to six months’ worth of expenses, including bills and other necessities. This formula seems logical at first; an emergency fund can help foster financial stability . However, is it possible to save too much?
According to a 2018 survey conducted by Bankrate , only 39 percent of Americans have enough savings to cover a $1,000 emergency. These survey respondents make up a plurality regarding financing a $1,000 crisis. The second most common response, at 19 percent, was to use a credit card to pay off the emergency over an extended time.
Given the extent of what Americans already owe their creditors (Northwestern Mutual’s 2018 Planning & Progress Study clocked the average personal debt exclusive of home mortgages at over $38,000), one might conclude that Americans need to save more for emergencies, not less. For the 28 percent of Americans without any savings at all, this may indeed be the case. It is certainly handy to have easily accessible funds during an emergency.
However, finance is not so simple, and not every method of saving for an emergency fund is the same. Here are a few issues to think about when it comes to your emergency fund.
HOW MUCH SHOULD YOU SAVE IN A DIVORCE EMERGENCY FUND
A savings account at a banking institution or credit union is often the choice for housing an emergency fund. These accounts are easily accessible and FDIC insured, which guarantees your principal remains safe in a market collapse. When your money is in a savings account, it earns about 0.5 percent of interest per year. The implication is your account will grow so long as you continue to save.
Nominally, this is true. But it is not necessarily true regarding your account’s real value; with such a low-interest rate, the value of your savings will likely decrease over the years instead of increase. Why? The U.S. inflation rate is currently at about 1.4 percent . That means the “dollar’s value will drop faster than it would grow in a savings account, making a traditional savings account earmarked for emergencies a poor choice for long-term growth, especially if that emergency never comes,” according to Jonathan Hornsby of Oak Tree Financial Services, LLC .
Because a credit card raises the amount of debt you have in your name, it is generally an unpopular and unwise option. But not for everyone.
Suppose you can use that credit card responsibly — you have the means to pay both principal and interest over a designated period instead of only the interest. In that case, you could safely pay for an emergency using debt.
But suppose you are uncomfortable with the possibility of digging yourself into debt yet also want to counteract long-run inflation built into a traditional savings account. “You could invest your emergency fund and receive a higher yield than what you would ordinarily from letting your money sit in a low interest-bearing account, but this comes with serious potential consequences,” says Hornsby.
The issue with investing is that your money would not be as accessible to you. By withdrawing money too soon, you could face penalties as well. Also, investing can be much riskier than keeping your emergency fund in a credit union or bank. Of course, that is the trade-off and why your upside is higher, too.
Alternatively, you could put your money into precious metals, like gold or silver, tying your emergency fund’s value to the asset’s market value. Assuming the real value of the asset holds over time, the value of your emergency fund would as well. Should the asset’s value increase, that would be even better. But do note the double-edged sword; the possibility exists that the asset’s value could decrease over time.
The same goes for buying jewelry, artwork, antique cars, and other collectibles. If you already own such assets, you may choose to hold onto them for a rainy day and sell them should an emergency arise. However, selling could take time if you even find a buyer, making them riskier choices to rely on for emergencies.
Regardless of how you choose to provide for an emergency, make sure your choice won’t worsen your financial situation. If you are not keen on letting your money sit in an account waiting for a disaster that may never happen, consider one of the savings methods more conducive to growth.
Likewise, if you are breaking your back to make ends meet or have debts to pay off , think about not saving for an emergency at all, at least for now. Rather, determine what will work best for your short- and long-term goals, weigh each option’s pros and cons, and make your financial decision from there. Keep in mind your choices, like your financial picture, can change.
Article was written by:
Charlotte Christian Law, P.C.
203 Eastside Sq Ste 8
Huntsville, AL 35801