Financial Planning 101 - The Emergency Fund. But What's The Real Reason?

in LeoFinance3 days ago

If you have ever spoken to a financial planner for more than 5 minutes regarding your fiscal picture, there's one phrase I bet you've heard.

If you have applied for a mortgage (as I recently have), dealt with a pension specialist or looked in to any kind of specialist investment you have likely heard one of two variations of it too...

1. Do you have an emergency fund?

2. How much is your emergency fund?

This is also written about extensively in books on the topic of wealth, investing or getting out of debt.

Do we really need an emergency fund?

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Well as the name implies if you knew whether you needed it or not, the word 'emergency' would probably not be included in the name of the fund, right? How many of us plan an emergency in our diary for the 24th of October next year, the definition of an emergency is:

A serious, unexpected, and often dangerous situation requiring immediate action. (Thank YOU Oxford English Dictionary, you never disappoint!)

Even if you have not been in the position of having discussed this with a financial professional, I'm certain you can imagine how that conversation would likely go.

An emergency fund is often used as a metric for deciding on the fiscal responsibility of one trying to obtain credit such a mortgage or large loan for a car, home improvements and such, especially if they have little credit history to draw on to exhibit this.

The obvious reason this is important is that if the loan is granted then the debtor loses his job or suffers a period of ill health, the size of the emergency fund will determine the length of time he is in a position to continue to meet his obligations whilst not being paid a wage or on a reduced wage.

In the event of an emergency fund being evaluated when it comes to making an investment or opening up a limited access bank account or ISA/IRA this is to assess whether the funds that are essentially being locked away or that may incur large penalties for being accessed will cause any financial hardship if the person taking out the financial product has a fall in income or again, loses their income.

Lenders and financial product brokers or salespeople can be found legally liable for that hardship if they do not assess the potential customer for affordability. It is much less about them being ethical, moral and responsible lenders who care, and more about them staying on the right side of financial regulatory legislation and thus avoiding litigation at some point down the line if you end up living on a park bench with a battered umbrella and some newspapers as your sole possessions.

Since the 2008 crash, preceded by the 'credit crunch' as it was euphemistically called, such checks and balances are routinely carried out in a way that they were routinely ignored during the boom-times, meaning that at the first sign of trouble, millions were sailing too close to the wind.

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Financial planners and tax and retirement specialists similarly place so much emphasis on the emergency fund because if they offer a tailored plan that causes financial jeopardy to you several years after following their recommendations, they can not do what most of us here would do when discussing financial planning and say:

This information is for illustrative and entertainment purposes only and should not be considered financial advice.

Because uhm... It is precisely financial advice and they do not wish to receive a good spanking from the financial ombudsman or other regulator.

All of the reasons outlined so far for saving up an emergency fund would appear valid. They all sound like a sensible precaution to shield us somewhat if the catastrophic or at the very least, the unexpected happens.

However my personal favourite reason in favour of having an emergency fund can be summed up in one word, I shall tell you what is in just a moment, but first, there is one more consideration that the professionals just don't seem able to agree on...

The precise length of time your emergency fund should provide a buffer against the unexpected for...

Many suggest 3 months. Others decry that this is simply not enough and 3 to 6 months is way more prudent. Yet others suggest, and at-least some of the books I have read on the topic, that you really need to insure your financial future for 1 year.

Maybe they are right but by the time you save up an entire years salary, the need you had to apply for credit has likely passed, your car may have finally given up the ghost or the favourable interest rates that existed when you planned to take outa mortgage to buy your home, may well have skyrocketed.

On this point there is some hope though. An emergency fund is not designed to be an entire year's worth of salary. The aim is to meet your essential obligations during a period of upheaval. Think food, clothing, medical, energy, rent, fuel and essential local/work travel.

Your emergency fund does not take in to account, luxuries, leisure, treats, eating out and vacations.

So what is your magic number? Take a little time to work it out if you want to enjoy a fiscally responsible future. It shouldn't take you long to work out your weekly expense and multiply it by 52 weeks and then choose how long you would like to be secured against emergency for.

I'm sure you can see the great benefit of doing this, the peace of mind you are securing for yourself and your family, if you have one. After all none of us has a crystal ball.

However this plan is always sold to us from a position of fear and some might say, dread.

How many financial product commercials have you noticed using phrases like the following?

Leave something behind for your loved ones if something should happen to you.

Peace of mind for you and your family if the worst should happen.

Don't let the unthinkable happen to you. Be prepared.

I choose an altogether different way of viewing the benefit of an emergency fund and I swear I won't forewarn of or even imply your untimely demise!

I hinted a few moments ago at being able to sum this all up in a more empowering way in just one word. I reckon it will give you far more incentive to prepare your fund and you may even find it an exciting proposition too.

So what is that one word I hear you cry? Ah that's simple Dear Reader

CHOICES...

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Knowing that you have exactly the right amount of money tucked away to provide for you for many, many rainy days to come does offer many choices about what you can and cannot do on an ongoing basis.

Imagine an amazing business opportunity comes along and you are unsure as to whether you can jump in with both feet.

Imagine that you have been looking for assets to pad out your balance sheet with passive income and exactly the right one comes along at a great price.

Interest rates plummet to all time lows and that money in your savings and investment account is barely working for you, in fact it's starting to look like it may have gone on strike! You could take out a mortgage on a rental property and maximise the gains from the tiny interest rate.

You stumble across the perfect crypto ICO or a traditional investment IPO and you are eager to jump in.

Any of the above opportunities could leave you in a tight spot financially but if your emergency fund is in place, you have the ultimate peace of mind that you can keep a roof above your head and food in your stomach whilst meeting all of your outgoings for a defined period of time.

Who knows, you may never experience an actual emergency, we all have bumps in the road at times but with proper financial management of your budget and assets these may be little more than a wrinkle in your future.

Many treat their financial lives as something that will just 'pan out' I would urge you to be different. I would urge you to be one of those rare individuals that actively 'manages' your finances. Whether you have a little or lot that needs to be managed today is not important, what is, is that if you engage in being active within your financial life and checking the numbers that matter and making the small course corrections that are essential at times, you stand a great chance of being independently wealthy one day.

Isn't that worth a little extra effort and study of a few basic financial principles?

Thank YOU for taking the time to read my post and if you're one of those amazing people who like to hit the comments section... Then I doubly thank YOU!

Either way I want you to know that you are appreciated!

Keep taking the time to connect with each-other both here and in the 'so-called' real world and try and look after each-other, because as you already know...

Together We're Just Better.png

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I am a proud member of the recently formed #TeamUK I love the global community immensely, but it is nice to have a home-team banner to add to my posts. The banner was made by the inimitable RoastMaster General himself @c0ff33a If you are an active UK member and would like to be added to the teamUK community on Discord, just let me know 😎

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It takes a long time time to save three months of Emergency cash reserves based on actual running expenses for a single parent household with kids, with sacrifices and not owning a car, and a few lucky breaks evening out the bad ones. With so much liquid cash, I am concerned about the loss of buying power and have to keep adding to the reserve. There are not many places to park the cash.

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Absolutely! We exchanged comments recently about the advice of broke financial planners, the ludicrous idea of them telling us exactly how we should handle our finances.

I spoke for the most part about this concept from an obtaining credit standpoint, as it was something I was advised I MUST do as my credit did not not like it would be sufficient for me to be able to obtain a mortgage, which proved to be the case.

For the vast majority of my grown up adult life I had nothing even close to an emergency fund, come to think of it, I never had more than £100 - £200 in savings of any kind. Don't get me wrong, with hindsight I take 100% responsibility for it although I didn't believe it was my fault at the time 🤦‍♂️

My mortgage broker took the saving history for my eventual EF and attached it to my application alongside my holiday pay entitlement from my job (13 weeks) and a statement I had prepared, explaining why I would be able to deal with up to 1 year of unemployment and I am happy to say it swung the decision and as of yesterday, I have my first ever foot on the property ladder as of... Yesterday, even though I turn 50 next year.

My workmates laughed at me when I started saving for an emergency fund as my initial amount I saved was £3 per week, my partner told me that could never work, however I gamified the process and made cuts and savings to get that to £5 then £10 per week. Next step, as I have mentioned here before, I took to eBay and other methods of earning a little extra ensued, despite having no other online skills to speak of.

As for loss of buying power, you are abso-bloody-lutely correct, inflation will prey on that sum like a monster, there is literally no negating this, except to say leave the money in the best possible place to at least offset some of the effects.

A savvier investor than me, may have been able to leave the money in a safe, secure place that gave higher yields but my only aim was to show a solid, dependable saving history with zero weekly savings gaps and it panned out for me in the end.

I guess also the idea of an emergency fund is to have immediate access if the worst should happen, in the past when this happened and we had zero reserves, we always relied on credit for the high risk borrower which cost us a tonne of interest through the years. Oh one final benefit, this enabled us to get a much, much better rate of interest on our mortgage than I could ever have dreamed of.

I empathise massively with, and remember pretty well, the situation you describe, it drove us in to 20K+ of credit debt although as I mentioned earlier, I now realise a lot of those early decisions are on me, but I guess if we were born wise and with all the skills we needed there would be no upside to getting older, right? 😁

Let's do our best and hope that crypto eventually solves the problems we all have financially and repays the loyalty and belief we displayed when many thought us fools!

Thanks ever so much for stopping by and sharing your thoughts and highlighting the biggest elephant in the room. Take good care of you and yours 😎👍

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I've done a pretty bad job over the years of ensuring that my wife and I have a decent emergency fund. The reason for that is because I have been actively paying down our debt, so while we have very little in terms of savings, we also have very little debt if any. Besides our mortgage, we are sitting pretty decent. Just recently I have started to work on our savings, but it is a slow process.

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This is a reasonable approach. Savings has been yielding very little compared to what it costs to have debt.

However, in some cases it may be better to go the other way. For example, if you have a mortgage costing you 3% interest and stablecoins are paying 10%, then savings may be preferable. At some point, your savings can generate enough interest to make payments on your mortgage. Wouldn't that be sweet?

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That would be pretty sweet. I don't really know anywhere I can get 10% interest though besides crypto which is very hard to buy into in the states (at least in that quantity) or stuff I am already doing like my Roth IRA and 403B.

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I'm in Texas, so there are limitations on stablecoins. Celsius pays 12.5% on stablecoins. Except, only DAI is available for Texans. Celsius convinced their bank that DAI is not a stablecoin.

Crypto.com is also paying between 6% and 12%, depending on your stake and terms.

There are others. Gemini, for example, pays interest, except on stablecoins. Voyager is paying 8.5% on USDC.

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I have some CRO staked over on Crypto.com. It seems to be a pretty cool platform. My credit card companies don't play friendly with it tough.

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You're 100% right. I have trouble even with debit cards on occasion.

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I hear ya man! Me too, life always seems to play the cruellest tricks at the worst possible time when it comes to home finance. If you noticed the enormous reply I made to Kerris on this post, I describe how once I started a family, we had a very meagre start to life and my emergency fund initially started with just £3 per week.

Although I knew that was virtually impossible to have a worthwhile fund that way, I wanted to automatically have that money taken from my account my wage goes in to so I was 'officially' saving, later I gamified the process to grow it faster, I know that without removing that amount (less than a decent coffee) I would never have gotten any further. Sometimes starting is everything and the amount is irrelevant.

Yes we have spent many years struggling against a mountain of debt that grew faster than our common sense when we were young and naïve. I now own all of those past mistakes although I didn't always feel that way.

I was actually accepted for my first ever mortgage yesterday, soon enough that will be my only outstanding debt too before it has even began being paid for and despite the fact I turn 50 next year. 😂

The newfound common sense and understanding the principles of sticking to a budget and money management should see my home paid off in 5 - 7 years.

Your process has probably saved you a small fortune in interest that would perhaps of kept accruing if you had saved for an EF earlier. Different things work for different situations.

It's been a while since we crossed paths, good to see you my friend I am incredibly happy to hear your financial journey is in decent shape. Take good care, best wishes to you and yours from me and mine 🙂

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Yeah, for sure. My wife and I had a pretty decent amount of debt when we first got together. We took out a five year balance transfer loan and that was probably the smartest thing we ever did. I think we were able to pay it off in three or four years an then it was just the normal type of stuff from there on out. Mortgage, auto loan, home improvement loan, recreational vehicle loan. We pay off any credit card bill as soon as it is due. We were also able to pay off her car and our RV loan a year or two early. My goal is to be able to pay cash outright for her next car. We will see how that goes. A good crypto run could make it more of a reality!

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One practical reason I have discovered for an emergency fund is related to choices. I recently had to make a large payment. My savings wasn't very large. And, I did not have places from which I could borrow the cash in the allotted time. So, I had to cash out some Bitcoin. No doubt this is costing me interest and capital gains. I am now a believer in the emergency fund. This way I can handle sudden cash needs without relying on credit or having to cash out investments.

It now makes sense to have savings again. Savings used to be en vogue when banks paid higher interest rates on deposits. As interest rates dropped, the math nerds convinced the world that it doesn't make sense to have cash sitting around in bank accounts. Well, with stablecoins, it is possible to have 10% or 12% interest on your savings. But, even if stablecoins did not earn interest, it would make sense to have a stash that can be deployed without harming your best investments.

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Agghhh no, you were forced to dip into BTC holdings. In the longrun, I don't think it will harm you too much, if anything the learning that comes from it is perhaps priceless for the longterm.

I myself failed to learn the lessons of not having an EF many times over but was too dumb to learn fast, but learn I did, eventually. It is absolutely true that having money sitting out of the 'yield game' can cost in terms of financial growth but compared to the many times I took on high interest credit to save us from the sky falling in, it is probably now paying for itself when large out of the blue expenses and repairs come along.

I did actually consider adding a stablecoin method to my post but I have a tendency to run on for an extra few thousand words when I explore every aspect of an idea that pops in to my head.😂

I love the way you worded that strategy though, safeguard not only your home-financial life but ALSO your best assets and investments. I think many of us have to learn financial intelligence through mistakes, they may be painful in the short-term but teach us valuable lessons in the long term.

If we learn from today and have a better tomorrow while planning for the day after, I think we are on the right track.

Thanks for stopping by and sharing your experience, it is massively appreciated, take good care of you and yours, me and mine wish you all the very best. 👍😎

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Thanks. What was more painful about selling BTC was that I had to sell it during a dip. Therefore, I had to sell more of it to come up with the amount of cash I needed. That was a high tuition for that lesson.

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Thanks for continuing to make Hive awesome.

Thanks for passing on a little encouragement ,especially to the newer folks here and making the place pretty awesome yourself 😎👍

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Covid taught me that we can't plan anything including Emergency Fund.

But financial education is a must.

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Choices are great to have. And this applies in other fields, too. For example, parents will ask me how much math their children need. I respond that they should continue taking math until they truly hit the wall (not everyone is wired for calculus.) Why? Because as soon as they stop taking math, they have placed a limit on future occupations they could choose. Which is fine if they don't want the option of being a physicist or engineer, but they need to understand that.

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