Imagine that you are home one day during a spring storm. It has been pouring for a few hours, so you decide to pass the time binge-watching your favorite television show or curled up with a good novel. You eventually get up from the couch to mill about the house, only to realize that your basement is filled with ankle-high water. Just like that, your day is turned upside down and an innocent rain storm has now transformed into an expensive and lengthy home repair process. This situation is more common than you might think, especially in the spring and summer months.
A flooded basement is undoubtedly a pricey hassle, but being prepared by maintaining a fully stocked emergency fund can help to mitigate the overall strain on your bank accounts. As a financial advisor, clients often ask me how to establish, build and maintain an emergency fund.
Here are a few things to keep in mind:
An emergency fund is essentially a savings account specifically reserved for unexpected events and emergencies such as a flooded basement, a car accident, emergency surgery or a sudden loss of income. Once established, it’s the responsibility of the account holder to stock the emergency fund over time. Most experts generally recommend having an emergency fund that can sustain living expenses for three to six months, but you can never truly have enough.
Establishing an emergency fund can be difficult because money that would otherwise be used on groceries, bills or new clothes must instead be put away for future use. Additionally, many people think that they will never be the victim of an emergency or that they will be able to handle any unexpected circumstances. However, it’s not that simple. An emergency or unexpected event can have a large, and often times negative, impact on your financial portfolio if you are not prepared.
Building and Maintaining
There are many different ways to build your emergency fund. Setting up automatic contributions from your paycheck or primary bank account is a popular strategy. This way, you avoid having to think about it each month. Choosing to allocate unexpected income, such as a work bonus or tax refund, toward an emergency fund is also a prudent idea. Remember, any extra money allocated is money that does not have to come from other critical areas. Although there is no right or wrong way to build an emergency fund, remaining consistent with contributions is key.
Maintaining the account is arguably the most difficult part of the process. It is important to remain disciplined and only utilize the money for emergencies. Resist the temptation to withdraw for usage in other areas. This will only hinder the progress you’ve made and decrease your level of financial preparedness.
An emergency fund is your safety net in the event of an unexpected crisis. It can help protect your finances, as well as expedite the recovery process. While every situation is different, having money specifically set aside for emergencies helps ensure that you can carry on with your day-to-day life while a remedy is sought.
Additionally, an emergency fund can help preserve other areas of your portfolio. If, for example, you are not financially prepared for an emergency, money originally reserved for college savings, charitable donations, or even big-ticket items such as a new house or car might need to be reallocated to cover the cost of the emergency. Essentially, an emergency fund provides an important buffer of cash for you to pull from before turning to other accounts or assets.
Whether your emergency fund is recently established or stocked with a sizable contribution built over time, having a safety net can help to provide an important and refreshing peace of mind.
Barbara Finder is a Senior Vice President and Financial Advisor with the Wealth Management Division of Morgan Stanley in Chicago. The information contained in this column is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, or its affiliates. Morgan Stanley Smith Barney, LLC, member SIPC