Every day I hear about “unexpected” things happening to individuals. Cars breaking down…stock market bubbles…pregnancy… But are all of these things really unexpected? Is there anything out there that is truly unexpected if you think about it. And, since they aren’t really unexpected, are you prepared? Do you just stash money away – maybe 6 or 8 months – like the financial pundits say, without really giving it any more thought?
Here are some things to think about when starting or adding to an “emergency” fund.
Thinking About the Unexpected
What you may call unexpected, I call consequence. If you own a car, maintenance will be required, and you really can know how much the maximum maintenance will cost. If you own a stock, you can know how much you can lose. If you have sex…well…you get the idea.
What it comes down to is calculating your worst case scenario. What if everything went wrong at once? How much would you be financially on the hook for (not to mention physically or emotionally)? Once you think about it, are you prepared?
Here is a quick overview of what my worst-case scenario would have been in college:
- Lost My Job
- Would prevent tuition payments
- Would prevent food purchases
- Would prevent rent payments
- Car Broke Down
- Couldn’t get to work or school
- Stock Market Crashed
- Loss of investment value
- Loss of ability to go to work or school (could be temporary or permanent)
- Family Illness
- Temporary or permanent need to move and/or provide care
Planning for the Unexpected
With your scenarios in mind, you can turn your attention to mitigating the risk. This is where your emergency fund comes into play, but it really includes so much more than a blanket statement saying “You need 6 months or 8 months saved in an emergency fund”. The real question should be for what and why do you have this emergency fund.
For job loss and car repair, an emergency fund is ideal. It is a lump of cash that can pay the bills until you can get back on your feet. For a car, the maximum repair bill probably would never exceed $5,000. If it does, you can probably get another car fairly easily for the same price. For losing a job, you can calculate how much you spend each month on food and rent, and you can bank that amount.
For investing, bubble happen. Black swan events happen. It is a fact about investing in the stock market. So you shouldn’t be caught off guard if it does happen. If the thought of suddenly losing 90% of your investments bother you to a point that you can’t sleep, then don’t invest in the stock market – keep your money in FDIC backed savings accounts. Stock market panics have been happening as long as there have been stock markets, so it is important to diversify, and to only place in the stock market what you don’t need for years and years to come. If you plan on using that investment money within the next 10 years, it is probably not the best place to put it. That is how you mitigate this risk.
For health care and family emergencies it is more challenging. For yourself personally, you can make sure that you have insurance – home insurance, health, disability, long-term care, natural disaster insurance, etc. I do this so that I can be prepared if something should happen.
It is much more challenging if you need to take care of a loved one. The best thing that you can do in the present is have the challenging financial conversations with them to try to ensure that they are prepared for the worst case. This will minimize the burden to you should anything occur.
Unexpected = Risk * Potential Event
What unexpected really means is that the person who had the unexpected event happen to them really wasn’t planning or thinking about the future. I’m a firm believer that all events can be planned for and mitigated, even if not in the absolute truest form. What I mean is that the variables of the event may be different, but with a little thought and planning, most things can be overcome without even breaking a sweat.
So, when it comes to planning an “emergency” fund, it is really more important than just saving 6 or 8 months of pay. What are your thoughts? Do you save more or less? Do you have other contingencies you would use?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.