When it comes to “surprise” expenses, the first thought may be a car breaking down, or a sudden medical emergency. However, these aren’t the only expenses that can balloon out of control quickly. There are many unknowns in life, and not everyone ends up with the same set of expenses or hardships, but everyone has unexpected costs they incur. Consider Alan’s fictional story:
A friend noticed a woodchuck in Alan’s yard last year. This year Alan noticed three of them, so he called a professional for trapping and relocating the animals because they were undermining his propane tanks. The quoted fee was $225 for the setup, $75 per animal. He figured that it would be worth the $450 to solve the problem.
The wildlife expert called a week later and said, “So far, I’ve caught 7 animals, and I don’t think I have them all yet.” The final bill was likely to exceed $1,000. That is a nasty, unexpected hit to the monthly budget. Even after realizing an unexpected expense was on the way and trimming luxuries, Alan’s carefully planned and balanced budget was ruined for that month. That meant Alan had to either dip into his savings or go into debt. Neither were attractive options, but humanely relocating the woodchucks meant less property damage later, so Alan was glad the bigger problem was taken care of.
If you wouldn’t be able to cover that kind of unexpected expense, you’re not alone.
The Bankrate 2024 Annual Emergency Fund Report revealed that only 44% of Americans would use cash on hand to cover a $1,000 emergency. Some 35% would borrow for the unexpected expense, including 21% who would put the expense on a credit card. The figures have largely been unchanged since 2022.
The most significant impediment to saving more, according to 63% of survey respondents, is high inflation raising the everyday costs of living. Rising interest rates were cited by 45%, and 41% reported that a change in employment status had a negative impact on saving.
Size of an emergency fund
Financial planners generally suggest that the first savings priority should be to accumulate an emergency fund sufficient to cover at least three months of ordinary expenses, and six months would be preferable in today’s volatile economy. According to the Bankrate survey, 66% of adults are worried that they don’t have enough funds to cover a single month of living expenses, including 42% who are very worried.
But the survey results were not all bad:
- Over half of employed Americans added to emergency savings at least monthly.
- Some 30% reported that their emergency fund was larger than the year before.
- Some 28% had enough savings for six months of expenses, and 16% enough for three to five months.
Credit card reliance
Our friend Alan reports that he’s going to put his woodchuck expense on his credit card, as he’s nowhere near his credit limit. His cash on hand is limited, but if truly necessary he could sell some mutual fund shares or borrow from his 401(k) plan.
Alan should pay off that credit card debt as soon as possible, because it is likely that his interest costs on the debt would be higher than his rate of return on his investments.
Interestingly, 47% of Generation X survey respondents reported that their emergency fund was larger than their credit card debt, while 47% said they owed more than their emergency resource. For millennials, the figures were 46% and 46% respectively, but 68% of Baby Boomers had more savings than debt.
Although it may be necessary to use debt to cover unexpected expenses, credit card debt is the most expensive type of debt to carry. Depending on the size and type of the expense, it may be worth exploring other options for debt. Some healthcare and dental establishments offer financing as well, with interest rates that will be considerably better than a credit card. Dipping into retirement funds should only be considered as a last resort, as you are losing out on all the gains during the time of the loan, and a distribution before full retirement age could incur additional tax penalties.
If possible, it would be better to be in that 44% that could cover the cost by creating and maintaining an emergency fund.
Steps to building an emergency fund
- Get Started. Start with opening a separate and distinct account and fund it with whatever is possible in your budget, even if that’s $25.
- Set your goal. Determine monthly expenses and multiply by six. Don’t overlook annual expenses, such as property taxes.
- Set a monthly objective. Make savings a routine monthly expense, prioritizing it above even small luxuries. Pay yourself first.
- Monitor your progress. Have an account designated as the emergency fund, preferably one such as a money market account that pays more in interest while still being liquid and readily available.
- Replenish any funds you use. The emergency fund shouldn’t be untouchable, but anytime it is tapped it will need to be topped up afterwards.
Once the goal is met, you can graduate to building your investment portfolio, which is the next step on the path to financial security. That is next month’s topic.
For more savings ideas or any assistance in developing a budget, make an appointment with an Arvest Wealth Management client advisor.
Our Solutions Center advisors can be reached at (888) 916-2121.
This content has been prepared by The Merrill Anderson Company and is intended as a general guideline.
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Arvest and its associates do not provide tax or legal advice. The information presented here is not intended as, and should not be considered, tax or legal advice. Consult your tax and legal advisors accordingly.