127: Modular Financial Planning 05: Emergency Fund Basics

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[00:00:00] Intro: Do you think money takes up more life space than it should? On this show, we discuss with and share stories from artists, authors, entrepreneurs, and advisors about how they mindfully minimize the time and energies. Spent thinking about money. Join your host, Jonathan DeYoe, and learn how to put money in its place and get more out of life.

[00:00:33] Jonathan DeYoe: Hey there. Welcome back to Mindful Money. We are in the middle of reviewing the Mindful Money Modular Financial Planning process, and last time we talked about adopting a savings habit saving. Essentially spending less than you earn is the iron wire once again, upon which all other, , modular financial planning steps may be hung.

If you don’t have a savings habit, you will not be financially successful. It is the first action step in the financial journey after you know what matters and where you’re going. [00:01:00] And today we’re gonna build further on this foundation of knowledge by introducing the first thing you’ll be saving into, which is your emergency fund.

This episode is the fifth in our 10 part series, which covers everything you need to know to get started creating your own DIY modular financial plan. As we all know, life comes with a fair amount of challenges. Your car breaks down, a tree falls on your house, you lose your job. The proverbial shit happens, but none of it has to get in your way so long as you have an emergency fund.

Once you’ve started the habit of saving, the first place to put that money is into an emergency fund. Nothing can derail your financial plan more quickly than an unexpected emergency. You’re not prepared to handle an emergency fund, helps you fix the immediate problem and stay on course towards your financial goals.

Further, it provides invaluable peace of mind in retirement. Your emergency fund allows you to afford your living expenses during periods of volatility in your investment portfolio without damaging the long-term income producing strength of that portfolio. At its [00:02:00] core, as you’ve heard me say, time and again, financial planning is the art of ensuring against what can go wrong in order to earn the luxury of investing for what can go right.

An emergency fund is your first line of defense. So first definitions. What is an emergency fund? Essentially, an emergency fund is significant amount of fully liquid cash in a simple savings account, high yield savings account, or money market account. After all, cash is the only financial instrument that is completely dependable in an emergency.

It’s readily available. Easily accessible and the value isn’t going to decrease like an investment account that will rise and fall with the market. You can’t know when the next temporary setback is gonna occur, so you must plan for it to happen at any time. The worst possible outcome of building an emergency fund is that you never use it, which if you really think about it, is both what you really want.

And the best scenario, the only downside in the case, , [00:03:00] is opportunity cost. The money your emergency fund would have made had you invested it. That being said, I’ve never met anyone who has not. Ever at some point needed to use an emergency fund.

So most people wonder how much they should have in an emergency fund.

Unfortunately, I have to say it depends. It isn’t a fixed number or a fixed percentage of income, or even a fixed number of months of expenses. Like so many people tend to talk about . The amount you should put aside an emergency fund depends on personal factors, age, income, lifestyle, and dependence.

Generally, the older you are and the more complex your life is, the , larger your emergency fund should be. When you’re young, all your things can fit into a single box. Life is simple. Your emergency fund needs are small. As a young adult, you probably have few more boxes of stuff, but you still typically have lower expenses.

Greater variety of job income prospects and fewer financial [00:04:00] responsibilities are dependent. So your emergency fund needs are higher, but still not that high. But as you age, you’ve got a whole lot more boxes of stuff , your life grows more complex. You might have a spouse, you might have purchased a home, you might have kids.

Your expenses go up, more people rely on you, and there’s a lot more risk if there’s an emergency or you lose your income. So to give you a better picture, let me break down the recommended emergency fund amounts by life stage. Note that what I’m talking about here is minimum recommendations. If you feel more comfortable holding a little bit more liquid cash in your emergency fund, by all means do it.

However, you gotta balance that feeling with the opportunity cost of putting extra into your long-term investments. Personal finance is a , long road, and compounding is your best friend on that road. The money you put into your emergency fund is not gonna compound the same way your invested money will.

For young adults, typically 18 to 35 years old, , you could be solo, you could be [00:05:00] coupled, or even families just starting out. So three months worth of expenses is the minimum. I would recommend you have, , saved in your liquid emergency fund. Bear in mind that needs to include all your expenses, not just regular monthly bills like rent or mortgage, , , electrical cable, phone service, but also out-of-pocket expenses like your food, gas, , entertainment, , and even some of those irregular expenses like insurance and property tax.

If you have that at a young age. As a young adult, it can be a challenge to save. That’s okay. No one, regardless of agent income, should expect to put away a full emergency fund and sort of one fell swoop. Instead, grow your emergency fund slowly and deliberately. If you can only afford to add 20 bucks, , per paycheck or per month, then do that.

At the very least, save a certain minimum amount to develop the habit. In your middle years, typically,, 35 to 55 years old, this is during the midpoint of your working life, while you’re growing and developing. Your earnings and your lifestyle costs are usually at their highest. You may be raising a [00:06:00] family or investing in future obligations like retirement or college tuition.

Amidst all these financial needs remains the possibility of various emergencies or even job loss. Since you don’t want to touch your investment portfolio, you need a bigger safety net and we suggest, you know, six to 12 months worth of expenses. Again, if you’ve got more complexity, , an expensive mortgage, multiple kids, or an irregular income, then maybe err on the side of a longer 12 month, , emergency fund.

As you approach retirement, you know in that 55 to 65 or 67 or so years old period, during these final years of your working life, you should strive to have 12 to 24 months worth of expenses in your emergency fund. Why so much? During the pre-retirement phase of our lives, we want to increase the emergency fund because the years immediately before retirement pose the greatest risk to your long-term financial health.

Just imagine [00:07:00] at retirement, much of your income is gonna come from your investment portfolio, which is subject to unpredictable market swings. A larger emergency fund protects you versus a down market in your early retirement years. There’s always a chance, , a market downturn happens. Right as you’re about to start withdrawing income from your portfolio,, , we simply cannot control or predict, , down markets.

So without an emergency fund, a major decline in the market could make you delay your retirement. Or worse yet, if you lose a job, or sort of have an unexpected emergency, you might need to tap your portfolio while it’s down. At the worst possible time under these conditions, your portfolio may not recover.

So forcing you to lower your lifestyle in retirement, a healthy emergency fund buys you valuable time for your investment portfolio to rebound finally in retirement, no matter the age you retire. in fact, if you retire earlier, this is even more important. You should maintain two [00:08:00] years of emergency savings.

Remember, retirement can last upward to 20 to 30 years or more if you retire before 65. An emergency fund will come in very handy when the markets inevitably tumble five to six times during that long span of retirement. After you’ve determined how many months your emergency fund should cover. You need to come up with a hard figure.

Here are three simple steps to help you calculate your minimum emergency fund value. First, calculate your budget. Add up all your monthly expenses, and don’t forget those infrequent things like property taxes and insurance. Then multiply that. Monthly expense total by the number of months of emergency expenses you plan to save.

And then finally, that’ll give you a total. And then finally, decide how much per month you’re gonna set aside to building this emergency fund and start saving that money in a separate bank account now.

Let’s assume you have the [00:09:00] emergency fund you need. When is it okay to dip into this fund? Well, only really you can answer that. So ultimately, an emergency must be a true emergency for you. It’s best to limit the use of the emergency fund to large unexpected need expenses. Storm damage to your house or a new radiator for the car and avoid using it for want expenses like a vacation you can’t really afford or a down payment on a new car.

These should be set up as separate savings goals. Perhaps of greatest need for most people is during a period of unemployment. A three month cash reserve can save you a lot of grief. , until you get back on your feet. , if you can tighten your belt a little, maybe you can make your emergency fund last a little bit longer.

but another legitimate emergency is to pay for medical expenses, which account for most bankruptcies in America. Even with good insurance, deductibles can run in the thousands of dollars, and a family out of pocket maximum might be 10 grand. , personally, we dipped into our [00:10:00] emergency fund in 2022.

Specifically for this reason, I spent four days in the hospital in. Late November 22 and our emergency fund covered my out of pocket maximum expenses. Then it happened again in early 2023. I burst a couple discs in my back and ended up hitting that maximum out of pocket. , again, two years in a row, , two emergencies, two years in a row.

No joke, shit happens. Ultimately, an emergency fund gives you breathing room and tight spots. Better to have an emergency fund and not need it, than need an emergency fund and not have it. An emergency funder is never going to stop bad things from happening to you, but it will equip you to deal with whatever comes your way.

Having cash on hand when you need it prevents the small setbacks from becoming huge disasters, and having the right kind of emergency fund gives you back control of your life. As always, thanks for listening. Next week, . we’ll be back. We’re going to continue on this path of talking about the mindful money, modular financial planning process.

We’re going to move on to the next step, which is eliminating high interest debt.

[00:10:59] Outro: [00:11:00] Thanks for listening. Full show notes for each episode, which includes a summary, key takeaways, quotes, and any resources mentioned are available at Mindful Money. Be sure to follow and subscribe wherever you listen to your favorite podcast. And if you’re enjoying the content and getting value from these episodes, please leave us a rating and review ratethispodcast.com/mindfulmoney. We’ll be sure to read those out on future episodes.