How lucky are we to be online teachers in this time? Countless people have been reaching out looking for online work. In US, the government is sending Americans stimulus checks and attempting to halt rent/mortgage payments. These are excellent short-term measures to help people avoid economic hardship. While they may have far-reaching and very negative consequences for the same people they are intended to help, they are absolutely necessary. However, the government can only do so much to help. I’ve written extensively on the importance of positioning yourself to invest in the market when it retreats from its historic highs (as it has during this crisis), but one thing that I’ve only touched on is the importance of an emergency fund. This week, I’m going to cover why you should have a minimum of six months of living expenses in reserve.
Why should you have an emergency fund?
Well… for emergencies. There are all types of emergencies- medical expenses, home repairs, or even helping out a family member. When most people think about the reasons for an emergency fund, they think of losing their jobs- not a global pandemic that grinds the world economy to a sudden halt. When your income is interrupted, your emergency fund should have enough cash to see you through until things improve. If you tap into your emergency fund, be sure to make building it back up your first priority.
Our current situation highlights the need for this sort of fund. In one of the financial groups that I’m in, we’ve had extensive discussion about emergency funds and how important they are today. One of the group’s members is a respiratory therapist in a hospital that is ill-equipped to fight the pandemic. Without the proper safety equipment (masks and gloves), she is putting her life on the line. Having access to a solid emergency fund gives her the option to not go to work if the hospital (or our president) can not take the steps to get them the supplies they need. If someone else in the same situation was reliant on that income to pay the bills, they would likely have to endure the risk. In her case, an emergency fund may literally be the difference between life and death.
It seems the government is offering some direct checks to Americans, but let’s be honest- how far is that going to get people? It might help for a few weeks, but people are going to need more. An emergency fund can help cushion the blow.
How much should you have in your emergency fund?
This is a matter of preference. Many people suggest six months’ salary. Others suggest six months’ expenses. Others say more. I personally plan to have at least a year’s worth of expenses in an emergency fund. A good rule of thumb is to have six months’ worth of expenses. This buys you time to find new work, undergo training if necessary, or (in our current situation) for the global pandemic and associated market downturn to begin to improve.
Let’s be clear, the larger your emergency fund, the more freedom and flexibility you have. Just twelve years ago we were faced with the greatest economic crisis since the Great Depression. Today, we’re being faced with the greatest economic crisis since the Great Depression. The markets and the economy in the US (and the world economy) are still not on solid footing. Corporations are so levered up and cheap money is driving an inflated stock market. A lot of it isn’t real. Until we retrace our steps and decide that we’re going to endure the pain necessary to get our economy back on solid ground, these violent swings are likely to continue. It’s best to position yourself to absorb any shock that comes from this volatility. That means having cash readily accessible to see you through the hard times.
Geoarbitrage is a great way to cut down on your living expenses, and hence to cut down on the cash needed in an emergency fund. In my book, I outline the benefits of taking advantage of LCOL countries to boost retirement savings and quality of life. Living in these countries also allows you to better absorb interruptions in your income because your daily living costs are lower. If your monthly expenses in an American city are $4,000, then your emergency fund should be $24,000. That’s a lotta dough! If you live in a country where it only costs you $1,000 a month to live, a $6,000 emergency fund can see you through for half the year.
As you build your income and your investments, build your emergency fund too. If you already have enough to feel comfortable, then consider adding slowly to it. Situations like the one we’re currently dealing with really show just how important these types of reserves can be when times get tough.
Where should my emergency fund be?
When it comes to your emergency fund, liquidity and stability are the two things you want to look for. By liquidity, I mean that you need cash that can easily be accessed. Having cash tied up in an illiquid investment (like a home or even a CD) is not going to help when you need cash quickly. While stocks are liquid assets, they carry incredible risk. The market just lost one-third of its value. If you have six months’ worth of expenses in an index fund and you need to tap it after the market collapses, now you’ve only got two-thirds (or four months’) of the expenses you thought you had. The same goes for metals. There are a lot of good reasons to buy gold or silver right now. Putting your emergency fund into metals is not a good idea. Any one of these investments might skyrocket and leave you with more cash than you thought you had, but that’s not the idea behind an emergency fund. It’s safety and security in hard times.
Look for a money market or a high-yield savings account. Interest rates are incredibly low. You’re not going to earn much on these. That’s the opportunity cost of having this type of savings. What you get in exchange is peace of mind and security knowing that you are covered if there is an unexpected negative occurrence.
What are the costs?
Like anything, there are opportunity costs to holding this sort of fund. As I said, the interest rates on demand deposits are incredibly low right now. This is money that you can’t invest. It’s money that could go to the down payment on a home. It’s money you could use to start a business. The important thing is to stay disciplined and don’t touch it. When you need it, it will be there.
It’s easy now to see the value of having an emergency fund. When times are good, nobody wants to worry about it. Try to remember the risk and uncertainty that surrounds us now and begin building your own emergency fund. As online teachers, we’re lucky to have a stable income in the face of this crisis. Take advantage of that to begin building up your savings. Don’t ignore the opportunity in the market, but be sure to position yourself for the day when we too may be impacted by a crisis of this magnitude.