By Senior Advisor Andrew Schaetzke, CFP® and Investment Associate Bobby Adusumilli, CFA.
Do you have money saved for emergencies?
Emergency savings can provide support in case something very unexpected happens. Unfortunately, most people and businesses don’t have enough saved. According to Bankrate’s 2021 Emergency Savings Survey, half of Americans have less than three months’ worth of expenses covered in an emergency fund.[1] That total includes 1 in 4 Americans who specified that they don’t have an emergency fund.[1] Based on research from the JPMorgan Chase Institute from 2016, approximately 50% of small businesses have 27 cash buffer days or less, meaning they would run out of cash within 27 days if revenue suddenly stopped coming in.[2]
By preparing for emergencies in advance, you are controlling what you can in order to be ready for the unexpected. Emergency savings can give you some peace of mind and allow you to maintain your focus on the long-term with your finances. We hope the below information helps you figure out what to do with your emergency savings.
How much should I save for emergency savings?
For most people, we recommend that you have at least 3-6 months' worth of living expenses in emergency savings. Some people like to have >1 years' worth of living expenses, particularly if they have health problems, dangerous jobs, or would just sleep better knowing they have more money saved.
How quickly should I fund my emergency savings?
Below are some general considerations, though please work with your financial professional to develop a plan appropriate for you:
First pay off any necessary short-term expenses.
Prioritize paying off any high-interest debts. However, many people like the security of also having emergency savings. Even if you prioritize paying off high-interest debts, you can still save slowly (such as $20 per week) for emergency savings.
After high-interest debts are paid off, prioritize growing your emergency savings to at least 3-6 months' worth of living expenses. While doing this, continue paying off any lower-interest debts.
After you paid off your high-interest debts and have enough emergency savings, then consider saving and investing more via tax-advantaged accounts. You can come up with a plan to help you save a little each week while also continuing to pay off any lower-interest debts.
When should I use my emergency savings?
When this cash is necessary for an urgent expense. While each situation is different, we typically recommend that people use their emergency savings before withdrawing from any long-term investments. However, we believe that people should replenish their emergency savings as soon as feasible.
Where should I keep my emergency savings?
The goal of emergency savings is to have cash for when you need it. Behaviorally, people are more likely to spend their savings unnecessarily if they frequently view the balance and if it is stored in the same place as other financial assets.[3] Therefore, we think people should keep their emergency savings separate from other financial assets.
Below are some options on where you can store your emergency savings:
Savings Account
Many online banks, local banks, and credit unions offer secure and low-hassle savings accounts that provide you with some monthly interest. The interest is subject to federal, state, and local income taxes, but the interest is usually more than you would receive in a checking account.
Make sure to choose a savings account which is FDIC-insured up to $250,000, as well as a trusted and reliable financial institution that will allow for quick and penalty-free withdrawals when needed.[4] For additional information on potential savings accounts, see this website from Nerdwallet.[5]
High-Quality Short-Term Bonds
Another option is to invest in high-quality short-term bonds. These bonds may provide more interest / yield than a savings account, but these bonds will fluctuate more in value compared to savings accounts. Certain high-quality short-term bonds (particularly municipal bonds) may be exempt from federal, state, and / or local taxes.
For many people, the easiest way to invest in high-quality short-term bonds is via a well-diversified low-cost ETF or mutual fund.
Short-Term Treasury Inflation Protected Securities (TIPS)
TIPS are offered by the US government to protect against inflation. The principal increases with inflation and decreases with deflation, as measured by the Consumer Price Index.[6] When it matures, you are paid the adjusted principal or original principal, whichever is greater. While TIPS are subject to federal income taxes, they are typically exempt from state and local taxes. Particularly if TIPS are in high demand, then investors may earn less than the rate of inflation.[6]
While you can buy short-term TIPS directly from the US government via the TreasuryDirect website, many people find it easiest to invest in TIPS via a well-diversified low-cost ETF or mutual fund.
Source: FRED, as of October 01, 2021. The Consumer Price Index for All Urban Consumers: All Items (CPIAUCSL) is a measure of the average monthly change in the price for goods and services paid by urban consumers between any two time periods. It can also represent the buying habits of urban consumers.
Series I Savings Bonds
Series I savings bonds are 30-year savings bonds offered to US residents by the US government, designed to match the US inflation rate.[7] Each individual can buy up to $10,000 of Series I savings bonds per year, and you can buy in increments of $25. You are restricted from selling your Series I savings bond within the first year, but after that you can redeem directly with the US government. If you sell within the first five years, you forfeit three months' worth of interest. When a Series I savings bond matures, you are paid the adjusted principal or original principal, whichever is greater. Series I savings bonds are subject to federal income taxes, but they are typically exempt from state and local taxes.[7]
You can buy Series I Savings Bond online directly from the US government via the TreasuryDirect website.
Conclusion
We can’t predict the future, but we can prepare for it. Particularly when times are toughest, that is when emergency savings can provide the most security for you. Emergency savings can help you weather the toughest times, providing a cushion so that you can stay committed to your financial plan for the long-term.
The idea of emergency savings is not new. The legendary investor Warren Buffett routinely talks about the importance of holding a large cash reserve for his company, largely driven by the teachings from his grandfather Ernest Buffett.[8] Below is a letter from Ernest Buffett to his family on the benefits of a cash reserve. [8] We hope you enjoy this, and as always feel free to reach out to us at SJS if you have any questions about emergency savings.
Source: “Berkshire Hathaway 2010 Shareholder Letter“. Warren Buffett, 2011, berkshirehathaway.com.
Important Disclosure Information & Sources:
[1] “Survey: More than half of Americans couldn’t cover three months of expenses with an emergency fund“. Sarah Foster, 21-Jul-2021, bankrate.com.
[2] “Cash is King: Flows, Balances, and Buffer Days: Evidence from 600,000 Small Businesses”. JPMorgan Chase & Co. Institute, September 2016, jpmorganchase.com.
[3] Your Money & Your Brain. Jason Zweig, 2008, Simon & Schuster.
[4] “Deposit Insurance FAQs.“ Federal Deposit Insurance Corporation, fdic.gov.
[5] “8 Best High-Yield Online Savings Accounts of November 2021“. Margarette Burnette, 01-Nov-2021, nerdwallet.com.
[6] “Treasury Inflation-Protected Securities (TIPS)“. U.S. Department of the Treasury, treasurydirect.gov.
[7] “Series I Savings Bonds“. U.S. Department of the Treasury, treasurydirect.gov.
[8] “Berkshire Hathaway 2010 Shareholder Letter“. Warren Buffett, 2011, berkshirehathaway.com.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
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