Saving & Investing
Why you need an emergency fund
March 05, 2014
Amy Chain: Tara asks us a question. Tara says, "I want to save money outside of my retirement savings for life expenses such as college, home improvements, weddings, etc. But I also want to have access to that money should an emergency arise. Is a low-risk mutual fund the best route?"
Mary Ryan: They're two different goals. There's a long-term goal and a short-term goal, and they're not the same. So college, retirement, all that, that's long term. You know, those are dollars that are not savings. They're your invested dollars. And so you can probably tap them, if you needed to, if something happened, but I would suggest strongly looking at having separate asset allocations for both of those different plans.
So having a short-term account for an emergency. It's an emergency fund. It's not an investment. And then having longer-term dollars that may be invested in mutual funds, stock funds, for longer-term investing; they're not your emergency fund. Two different things.
Amy Chain: So let's talk about that for a minute. We've got a lot of questions about emergency funds coming in today. We have a question from Chuck from Dallas, not Chuck from Valley Forge. But Chuck from Dallas wants to know where we might recommend putting money that we need for an emergency.
Chuck Riley: So even though money market funds are not really paying anything—they're essentially paying nothing—a money market fund is a great place to keep the cash for an emergency fund. And the thing that I like to remind clients about that money: Once that money is in a money market fund, that's your emergency fund, your cash reserve, it's no longer an investment. That's really an insurance policy that you've created for yourself. It's not costing you anything. In a money market fund, you're not making anything either, but that's not the purpose. Any money that you would have made, even if money markets were paying 1% or 2% or 3%, it doesn't change your financial picture.
But the most important thing is that it's liquid and that you can get your hands on it quickly to meet that short-term emergency-spending need. If you want to use a savings account, like some of the online savings accounts—and they pay a little bit of interest, but it's still very liquid—if you wanted to do that, that would be fine. But the chief thing with an emergency fund is liquidity and accessibility.
Amy Chain: Okay, so we've got the short-term emergency fund covered. Mary, you alluded a little bit to longer term goals and how you should be thinking about investing or not investing money for longer-term goals. What kind of guidance can we give our viewers for how to think about some of the longer-term things on their mind?
Mary Ryan: Again, because we're looking longer term, we have more time. So if the markets fluctuate, things like that, you've got time to ride this out. Whereas an emergency fund, market goes down, hmm, you need that money; well, that's not a real good time to take it out.
So when looking long term, you need to look at your time frame. What time are you thinking about? Is it a 5-, 10-, 15-, 30-year goal? And then what is your risk tolerance? How comfortable are you with risk? Understanding that if you don't take any risk, your return is probably not going to be maybe what you need. So look at your risk tolerance and then coming up with a good asset allocation. And that asset allocation being the relationship in the account between stocks and bonds. How much do you have in stocks and bonds? The longer your time frame, perhaps the more aggressive you might want to be, just to consider that.
Amy Chain: We had a few questions about how aggressive should I be. Krishon actually asked a question that alluded to that. And if I'm hearing you, the answer is if it's short term, if you're going to need the money quickly, don't worry about how much you're going to make on the money. You need to make sure that it's there for you when you need it.
Chuck Riley: Right.
Amy Chain: And then your asset allocation and the amount of risk that you take on can vary, depending on your tolerance and your time horizon for longer-term goals.
Mary Ryan: Um-hmm, exactly.
Chuck Riley: Exactly, well put.
Amy Chain: Okay, we have a live question that just came in. This comes in from Michael from Charlotte, North Carolina, where we also have a Vanguard office. They got a lot of snow these last few weeks as well.
Mary Ryan: Yeah, they got the ice and stuff.
Amy Chain: Our poor friends in Charlotte are shivering. Michael, I hope you're not. Michael wants to know: "Advice for choosing a financial advisor—what do we think?"
Mary Ryan: There's a lot that goes into that, and I think interviewing— First, no, let's take a step back. I think looking at it and deciding what do you want, what is your goal with this financial advisor, what are you looking for that financial advisor to do for you? And once you can try to figure out, "I'm looking for that financial advisor to do 'X,' maybe to just help me pick the mutual funds and balance it, or I'd like a financial advisor that's really going to look at my whole financial plan, that knows about estate planning and all of that, is familiar with taxes," things like that. So you need to decide what do you want that advisor to do.
And I certainly would never be afraid to ask very pointed questions of the advisor: What is their background? Tell me about what you've done in the past. How many clients do you have? How much time do you spend with your clients? Whatever's important to you, don't be afraid to ask. Don't be afraid to ask, "How do you get paid?" You know, those are important questions. And I think when we talk to people and talk to advisors, it can be a little intimidating because you feel like well maybe they know a lot more than I know, so I'm not really sure what questions to ask. But at the end of the day, it's your money. You need to understand with whom you're working and have a good, comfortable honest relationship with that person.
Amy Chain: We've used the analogy before. It's sort of like you don't marry the first person you meet. You date a little bit.
Mary Ryan: Right, right, right.
Amy Chain: So talk to financial advisors—different folks can serve different needs—and talk to them and figure out which is the best fit for you.
Chuck Riley: Yeah, and don't be afraid to ask the financial advisor questions, to give them information about you, your overall situation, and say, "How have you handled clients like myself in this situation before?" And I think one of the keys for getting a good advisor is finding one who's going to ask a lot of questions. They're going to look to say, "Well, what are your goals?" Learn more about you, who you are as a person, before they really give you any kind of advice. Because they really can't, and I think a lot of the nature of advice today is, "Well, I can know, I can predict which way the market's going to go, and I'm going to make sure that you're going to not be in that bad position."
Honestly, the biggest way to make investment decisions is first knowing who you are, what your issues are that you're facing, and then finding you a good plan to deal with those issues, and it's different for everybody. But it all starts with asking questions, getting to know who you are.
Amy Chain: We have a live question that just came in from Michael, going back to the emergency fund conversation we were just talking about. So let's get Michael's question in.
He wants to talk again about: "Emergency funds should be for how long, what type of expenses? Should we think about six months, three months, one year? What's the right kind of emergency fund to think about having?"
Mary Ryan: Well, again, everybody's situation's different. So to start with that, there is a general rule of thumb that you want to look at somewhere having between six months to a year of expenses—you know, dollars set aside for expenses and things like that—just to have that there available to you should you need it.
But, again, everybody's situation's different, and when you decide how much to set aside, you need to think about your job. If you've got a job that you think is pretty secure, "I don't see any real worries," well that's one thing. But then somebody else may be in a position that, "Umm, I'm not sure what's going to happen" or you're self-employed or something like that; that can change things. And you may need to have more set aside in an emergency fund.
And it can be sometimes very frustrating to people that say, "Well, I'm going to have all this money sitting there not working for me. Boy, that just doesn't make a lot of sense." But it makes a whole lot more sense having it sit there. When you need it—the market's gone down, you've lost your job—you need your money, and it just isn't there for you.
Amy Chain: The whole point of planning for the unexpected is that you can't expect it.
Mary Ryan: Exactly.
Amy Chain: So when you do get hit with the unexpected, it's so nice to know that you have this money there.
Mary Ryan: Yes, that it's there for you.
Chuck Riley: Yeah, and one of the nice things about having an emergency fund or just planning for the unexpected is that when the unexpected happens, you don't feel as anxious. I remember the first time like I built up my emergency fund, and the car broke down, and we needed to pay—it was a large repair—I didn't even think about it. I just paid it. And I wasn't worried about it. Yeah, it was a hassle kind of trying to figure out the car, but it was such a relief to be able to know, you know, I didn't know when the car was going to break down. I didn't know that it was going to break down. But the peace of mind that you get when you're, and you can't plan for everything, but—
Amy Chain: It can take the stress down in a stressful situation—
Chuck Riley: Absolutely.
Amy Chain: —if that's not one of the things that you're stressing over.
Chuck Riley: That's right. And in my experience of working with clients, stress is the enemy of good decisions. When you're stressed out, you're not going to make good decisions. You need to be able to be in a good frame of mind. And you'd be surprised how the folks that weren't prepared for 2008 handled things a lot more differently than the folks who were going through the same thing, but who were comfortable with the allocation that they'd chosen, the planning that they had done, and they rode it out, and they fared a lot better.
Amy Chain: This gets back to being really honest with yourself about what is your risk tolerance.
Mary Ryan: Right.
Amy Chain: Could you sleep at night if your portfolio lost a little bit? If not, then rethink your allocation.
Mary Ryan: And what's your plan if that happens? What are you going to do? If the market goes down, how are you going to react and to be honest with yourself on that one because a lot of times with the market going up like it's been, last year, everybody said, "Oh, I'll be fine." Hmm, until it happens.
Amy Chain: We have short memories, right?
Mary Ryan: Yes, until it happens.
Chuck Riley: Right, exactly.
Mary Ryan: So, there again, to be honest.
All investing is subject to risk, including the possible loss of the money you invest.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
Vanguard Asset Management Services are provided by Vanguard National Trust Company, which is a federally chartered, limited-purpose trust company operated under the supervision of the Office of the Comptroller of the Currency.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.
© 2014 The Vanguard Group, Inc. All rights reserved.
Have cash on hand to meet immediate expenses
You may not know when you'll need it but you'll be glad you have it: Cash reserves on hand to meet short-term needs. Chuck Riley from Vanguard Advice Services™ and Mary Ryan of Vanguard Asset Management Services™ explain one of the few times when investing isn't necessarily an investment.
Other excerpts from this webcast:
- All investing is subject to risk, including the possible loss of the money you invest.
- An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
- Vanguard Asset Management Services are provided by Vanguard National Trust Company, which is a federally chartered, limited-purpose trust company operated under the supervision of the Office of the Comptroller of the Currency.
- Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
- This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.