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Preparing for the Unexpected

Preparing for the Unexpected

June 05, 2018

40% of Americans don’t have cash on hand to pay for a $400 emergency expense.

Think about that for a moment. A new report from the Federal Reserve found four out of 10 Americans, when faced with an unexpected expense, couldn’t cover it because they don’t have the money.

If a car breaks down, they will struggle with how to pay for the repairs. If the refrigerator stops working, they will stress about how to buy a new one. If they lose their job, they will scramble to make the house payment and buy groceries.

The thing is, emergencies are a fact of life. They can and do happen. They are stressful, they are worrisome, and they are scary. What if one of the above scenarios happened to you? How would you pay for new brake pads in your car? What if your roof starts leaking? What if you need a costly dental procedure and insurance won’t cover it all?

Some people would have no choice but to use a credit card. They don’t have the cash on hand to cover the expense, so they go into debt. WalletHub conducted a credit card debt survey in 2018. They found the United States has a combined $958.6 billion in credit card debt, with the average household owing $8,200. Indeed, credit card debt can certainly be a barrier to saving. 30% of people in the survey said they have a difficult time saving for an emergency because they are struggling to pay their debts, in addition to all their other expenses.

Saving money isn’t always easy, and of course you can always find lots of uses for that money instead of simply stockpiling it. But when faced with an unexpected expense, having a financial foundation is likely to be less painful.

Some Americans say they’re already creating a financial foundation by contributing to a 401(k) or other retirement plan. They may be thinking: “the money is mine, so what’s the harm in borrowing from myself?”  Turns out, taking a loan against your 401(k) is one of the worst money moves you can make. There is a 10% penalty for withdrawing before age 59 1/2. You will be charged added interest and fees, and your future contributions could be suspended until you’ve paid the loan off. CNBC says your take-home pay will be reduced because of the automatic paycheck deductions to pay the loan back, you’ll incur double taxation and if you leave your employer, the loan will be due within 90 days. A 2013 Fidelity study also found that 66% of 401(k) borrowers took out more than one loan, compounding the problem.

So avoid that nightmare scenario and start building up a cash reserve you can easily access. Advisors with Compass Financial Services suggest building an emergency fund of three to six months worth of living expenses. How do you get at that number? Look at your budget and determine what it really takes for your family to live every month. Multiply that number by 6 and that’s your target.

You’ll want to set the money aside, but keep it accessible. If you are faced with an emergency, you may need to get your hands on the money rather quickly. But you don’t want to be tempted to spend the money on a whim. Keep the money in a separate savings or money market account. You’ll know exactly how much money you have, and how much you still need to save. Work with your partner to determine the rules of spending: what expenses can the emergency fund be used for? Do you both need to be in agreement? What is the repayment plan if you do access the money?

Having an emergency fund provides you with both financial stability and peace of mind. It can turn a stressful emergency into a simple inconvenience. Start saving today!