It’s a Jungle Out There
Many Americans learned about the importance of a financial safety net the hard way when the COVID-19 pandemic hit the U.S. in early 2020, causing business closures, high unemployment, and various health-related concerns due to the virus.
Stimulus and extra unemployment insurance were eventually rolled out, but many who lost jobs in March 2020 were forced to dip into savings to keep their bills paid.
The pandemic has shown that threats to our personal and financial well-being often come out of nowhere. Car accidents, heart attacks, and job losses don’t give us forewarning – they just show up and wreak havoc.
That’s why building a financial safety net is more involved than just opening a savings account. You need a comprehensive plan to deal with emergencies because by definition, no one knows when (or how) those emergencies will arrive.
The common question is how much should my emergency fund be? Read on and take these careful steps in creating an emergency fund.
Consider Your Goals and Monthly Obligations
The first thing you need to ask is what your financial safety net needs to protect. Are you a single 25-year-old individual renting an apartment? If so, your safety net will probably look much different than the one created by a 50-year-old parent of three. A parent has much more to consider as far as insurance and monthly bills, while the younger individual can focus more on their personal well-being and financial needs.
When building a financial safety net, there are three main categories to consider and all will require some funding. These categories are:
- Savings
- Insurance
- Investment
Again, not everyone will need the same level of emergency savings or life insurance. But we all need some form of savings, insurance, and investment to ensure covering our expenses and bills should something unexpected occur.
Emergency Savings
Creating a savings account for emergency purposes can feel like a tedious task for beginners. The mere thought can start to create financial stress. However, once you organize monthly pay portions into a low-interest savings account (where it compounds little), this financial safety net can provide much peace of mind.
The goal of an emergency fund isn’t to compound interest, but to provide a buffer between you and the bill collectors should you become unable to produce income for an extended period.
How much should my emergency fund be? A good rule of thumb is to have at least three months of expenses saved. If you can, six months would be even better. As mentioned above, mapping out your monthly expenses will give you a ballpark of how much you should save to create a comfortable emergency fund.
If you were in an accident and couldn’t work for three months, would you have enough to cover all your expenses plus any outstanding medical bills or insurance deductibles? If the math shows that a hospital stay or at-fault accident would sap your emergency fund quickly, you may need to consider more monthly contributions.
Your emergency savings fund should be left alone until you have an actual reason to use it. Don’t fund vacations, car buying, or other durable goods purchases with your emergency fund. A vacation or car fund should be kept in a separate account.
The reason you keep your emergency fund in a savings account is that you need the cash to stay liquid and not lose any principal. Yes, the meager savings rates offered at banks won’t keep up with inflation, but emergency funds aren’t meant to beat inflation. They’re meant to be easily accessed when you need them.
Insurance
As you are well aware, various insurance is needed in our economy: healthcare; homeowners or renters insurance; and (if you own a car) auto insurance. Even the youngest, healthiest person on the planet can break an ankle, tear a shoulder muscle, or get ill from a virus-like COVID, so health insurance is an absolute necessity.
Homeowner and renter’s insurance protects your valuable property from theft and destruction – a requirement for those who take out a loan. Maintaining auto insurance is a legal requirement if you want to drive a vehicle. However, other types of insurance come down to matters of personal preference.
The 25-year-old renter can probably get by with health, auto, and renter’s insurance. What about the 50-year-old parent? Life insurance, disability insurance, and long-term care insurance are serious considerations. When life gets more dynamic so should your financial safety net.
Life insurance protects your family should you pass unexpectedly. Check out the best life insurance companies of 2022. Disability insurance protects your paycheck should you get injured and become unable to work. Refer to the best disability insurance companies. Long-term care insurance prevents you from becoming a burden to your loved ones as the aging process slows physical or mental faculties. View the six best long-term disability insurance companies.
No one likes to think about dying or getting hurt, but these situations must be considered, especially if you have family dependents.
Have you built your financial safety net yet? Schedule a no-obligation conversation with Ascendant Financial Solutions to see how we can help.
Investment
Investing usually isn’t considered part of a financial safety net since it’s often used to prepare for something we see coming decades in advance – retirement. A tax-deferred retirement account is certainly part of a financial safety net because it allows us to quit working on our terms and not be dependent on the government for sustenance in our golden years.
Tax-deferred accounts like 401(k) accounts and IRAs are crucial for building a retirement nest egg. These accounts allow for tax deductions now and push the bill out into the future (ideally in retirement when our tax rate will be much lower). And unlike an emergency fund, it’s okay to take risks with retirement funds since it’s often a multi-decade process.
Investing isn’t just for our futures, either. Tax breaks also come with investment accounts like 529 Plans and Coverdell Education Savings Accounts (ESA), which are vehicles for education expenses. Funds put into these accounts will grow tax-deferred as long as withdrawals are used for qualified education expenses.
Health Savings Accounts (HSA) also provide tax savings if funds are used for medical costs. Don’t start funding these tax-deferred accounts until you build your emergency fund and purchase proper insurance. Need help getting started? Contact Ascendant financial advisors in AZ and ask about the best way to start constructing your financial safety net.
Catch Your Fall
The future is uncertain. Just as you assess the 2022 stock market outlook concerning the inflation from the pandemic, you must develop the skills to catch your fall. If you haven’t already taken the important steps to build a solid financial safety net, get started now. Reach out to your financial advisory firm in Arizona for assistance.
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