I started my blog in January to provide information that will help you make more informed financial decisions.
A few weeks ago, I was introduced to the Center for Financial Services Innovation (CFSI), a network of financial service innovators who try to build better consumer products and practices. The mission of CFSI is to improve the financial health of Americans.
CFSI has partnered up with FinCon (the world’s largest Financial Content Expo) to sponsor a blog post writing contest that looks to describe “What Financial Health Means to Me”.
Today’s writing will answer the above question while holding true to the mission statement of this blog.
I was provided a number of comments to choose from as inspiration but this one really stuck with me:
“Households that plan ahead for large, irregular expenses are 10 times as likely to be in the financially healthy segments than those that do not plan ahead.”
The main reason I see financial plans derailed is that people don’t prepare for the unexpected. Now I know that sounds strange, how do you prepare for what you don’t know? You plan for the unexpected with an emergency fund.
An emergency fund is just what it sounds. It’s not a savings account or a vacation fund. It is money specifically set aside for the unknown expense that occur. Basements flood, car’s need repair, and accidents happen. An emergency fund should hold cash or cash equivalents (an example of a cash equivalent is a money market fund) and be easily accessible to pay for these events.
So why would you want to save money in an account that is not getting you closer to achieving your goals? Because by not building an emergency account you will draw funds from your other goals when the unexpected happens. If they don’t come from another goal you will probably need to take on debt to pay for them.
So how much do you need?
The rule of thumb is to hold anywhere from 3-12 months of expenses in your fund. The idea is that if you lose your job or have a large unexpected expense this would be enough cash to pay for the cost.
That’s a wide range, so what works for you?
For many families living paycheck to paycheck, having the equivalent of 12 months of expenses in cash is unrealistic. From a purely investment standpoint, having this much cash on hand in today’s low interest rate environment doesn’t make sense since returns are so low.
Despite this, I have clients who just won’t sleep during the night if they don’t have large amounts of cash available at all times. This is great example of where some additional return is just not worth your peace of mind. The extra return makes sense on paper, but it’s not worth it if you are anxious and can’t sleep.
The answer of how much depends on many factors such as your job, your health, and your marketability, but mostly on what feels right for you.
This is just one instance of how planning ahead can improve your financial health.
So what does financial health mean to me?
Being financially healthy is committing to the process of planning to improve your chances of achieving your goals.
As Benjamin Franklin said, “Failure to plan is planning to fail.”