The events of 2020 will remain in our memories for many years and for many reasons. As financial planners, it has helped us to highlight just how vital it is for everyone to have an emergency fund as part of their broader financial plan. It’s a practical piece of financial planning that can bring security, continuity and peace of mind in unexpected circumstances.
Dealing with the unexpected
When most people think of financial advice they think of receiving guidance on where and how to invest their funds, how to structure their assets to save tax, or how to build a financial plan that will help them achieve their goals in life. An area that is just as important as all of these is the need to set aside a cash buffer or emergency fund for dealing with the unexpected.
All good financial planners will have a conversation with their clients about how much cash they need to hold for emergencies. Anecdotal advice suggests that people should hold three-to-six months’ worth of general expenditure in cash for emergencies, but it shouldn’t be a one-size-fits-all calculation. The amount will differ, depending on the individual and their circumstances.
There are a number of different factors involved but, for example, your stage of life or working circumstances can influence how much you should retain in case of emergencies. Someone who is retired with a guaranteed income stream from a secure pension may require less of an emergency fund than a contractor who has to win new projects and may be out of work for a number of months.
A planner will work with you to establish your financial needs and understand your individual circumstances. They will help you discuss any concerns you have for your financial future and assess the risks and likelihood of potential events and the financial impact they could have. From here they can help to calculate just how much you should be retaining in case of emergencies. It’s important to note that working out and setting aside this cash buffer should come before you even think about investing.
Emotional element
We also tend to find there can be an emotional element when it comes to deciding how much to hold in an emergency fund. It can help to break this down with clients to understand what’s driving their thinking. I recently spoke to a client who said they would feel safer with a much larger sum in their bank account than their calculations suggested. However, after further conversation, they could not remember a single point in their life where they had needed even 10% of the figure they had in mind. It is a conversation like this that can help an individual to find out what really works for them.
Part of an adviser’s role in this situation can also be to remind people that holding too much cash comes with risks too. Keeping significantly more than they need as a cash buffer means that this money is not being invested and therefore typically grows at a rate lower than inflation, meaning the real spending power of the money is eroding each year. Holding too large an emergency fund can therefore mean that your funds are not working for you as efficiently as they could be.
Retaining a sensible and sufficient emergency fund, without hurting your long-term prospects, is a fine balancing act, but one that we encounter on a daily basis. There is never a one-size-fits-all answer, however, working with a financial planner can help you to strike a balance that works for you. The goal is for you to feel comfortable with your position and to rest assured that if something did go wrong, you have a plan in place to deal with that eventuality.
If you would like some help with your financial planning, please get in touch.
