Poll Shows Many Personal Emergency Funds Lacking
June 07, 2010
A recent poll found that the cash reserves people have in emergency funds is most commonly less than three months' worth of expenses. Strong evidence suggests this is simply not enough.
The poll, conducted jointly by MoneyRates.com and GetRichSlowly.org, found that 37% of respondents had less than three months' worth of reserves in their emergency funds. A quarter (25%) had three to six months' worth, 14% had seven to 12 months' worth, and 15% had over a year's worth. A remaining 9% had no emergency fund at all.
An emergency fund is a cornerstone of financial security, because having one means that if you're hit with an unexpected expense or drop in income, you don't have to immediately go into debt to cover the shortfall. In fact, building an emergency fund--or rebuilding it if you recently had to draw on one--is so critical that we made it MoneyRates.com's June resolution.
But what is the right amount of reserves to have in an emergency fund? It's hard to say, because emergencies are, by nature, unpredictable. Their duration and costliness can vary. However, there is data to suggest that a three-month reserve may not be adequate.
Unemployment and Other Emergencies
One of the most common financial emergencies is losing a job. An emergency fund can be an essential supplement to unemployment benefits in tiding you over until you find a new job. That process of landing another job now often takes considerably more than three months.
According to data from the US Bureau of Labor Statistics, as of March 2010, most (60.5%) unemployed people had been out of work for at least three months (15 weeks or more), and 44.1% of the unemployed had been out of work for 27 weeks or more, which is more than six months.
It's true that these unemployment statistics reflect a still-weak job market in the wake of a devastating recession, but face it--that's exactly the type of situation in which emergency funds are often needed.
Of course, unemployment is just one form of financial emergency. Accident, illness, or property damage might cause you to miss work plus while facing expenses well beyond the ordinary. In those cases, you might run though your cash reserves much more quickly than expected.
Build an Emergency Fund in a Money Market Account
Overall, the MoneyRates.com/GetRichSlowly.org poll found that 62% of respondents' emergency funds would cover expenses for only six months or less. It's possible that this low level of reserves partially reflects the effects of these funds being drawn down during a tight economy--and in fact, the same poll question asked in January found that most respondents had emergency funds that would last longer than six months. Therein might lie the answer to how to view your emergency fund--it shouldn't be static, and its length may vary according to conditions.
What this means is that you should not set an arbitrary figure, such as three or six months, for the length of your emergency fund. Six months is a good starting point, but when things are going well, continue to add to the emergency fund bit by bit. At that point, most of your savings should also be going to longer-term goals like retirement, but keep setting a little aside to build up your emergency fund.
Where should you stash your emergency fund? Money market accounts offer higher rates on average than savings accounts, and money market rates can be about on par with short-term CD rates--without the associated penalty for early withdrawal.
Avoid investing your emergency fund in stocks. You should typically avoid disrupting long-term investments like stocks in an emergency, because that can damage your long-term financial health--and when you need those funds is often when the value of those stocks have dropped during a broader economic downturn. CDs, even laddered short-term CDs, are also not an ideal choice because of the early withdrawal penalty associated with the typical CD. Dealing with the unexpected--sometimes on short notice--is what emergency funds are all about.
