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How big should your emergency fund be?

July 27, 2014
By SAMUEL ZIMMERMAN , Leader Herald

An emergency fund can provide a financial cushion in the event of a loss of income. But today's low interest rates and longer time between jobs may require a reconsideration of the old rules of thumb.

According to research by bankrate.com 67 percent of Americans have an emergency fund that holds enough to cover at least three months of expenses.

Access to an emergency fund is essential in the event of an unexpected event that reduces your regular income.

Emergency funds have the potential to help cover your everyday expenses so you can avoid tapping into your savings for retirement, college and other long-term needs.

There are a number of considerations in determining the amount to put aside for short-term needs.

It must first be stated, however, that the question is often answered not by a dollar figure, but in terms of the length of time an individual believes the funds will be needed.

Consider, as well, that today's low interest rates translate into a relatively low gain on the account, necessitating a greater level of savings or new strategies for investing for the short term.

We will examine first the question of the time period for which to cover.

An old rule of thumb states that an emergency fund should consist of three to six months' worth of expenses.

This may not be sufficient in today's environment due to low interest rates and long stretches of unemployment.

In an April 2014 report, the U.S. Department of Labor stated that 57 percent of unemployed Americans were out of work for at least 15 weeks.

The same report showed 38 percent had been unemployed for at least 27 weeks.

The same report concluded that the average length of unemployment, without seasonal adjustments, was 37 weeks, or roughly eight-and-a-half months.

Revisiting the Bankrate.com study, only 24 percent of respondents had at least six months' of savings in their emergency accounts.

In terms of vehicles, savings accounts or money-market mutual funds offer instant access, although current yields are low and may not keep up with inflation.

You may also be able to use your Roth IRA as an option, as Roth IRA owners may withdraw their contribution principal at any time for any reason, without tax or penalty.

Roth IRA withdrawal of earnings or conversion amounts under specific circumstances may be subject to taxes and penalty.

One thing you will want to think about is the percentage of current income you would want to replace, which may be less than 100 percent depending upon your current income and expenses.

On the other hand, you may need a larger emergency fund if you have a mortgage, children and/or a non-working spouse.

Finally, no matter how much you set aside and how you choose to allocate your short-term savings, revisit your plan periodically to make sure you are on track as living expenses rise.

 
 

 

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