During the coronavirus pandemic our health concerns, for ourselves and our loved ones, have been at the top of our minds. But financial worries have been there, too, both for people whose employment has been affected and for investors anxious about the volatile financial markets. And one aspect of every individual’s total financial picture has become quite clear—the importance of an emergency fund.
Even in normal times, it’s a good idea for you to keep three to six months’ worth of living expenses in a liquid, low-risk account. Having an emergency fund available can help you cope with those large, unexpected costs, such as a major car repair or a costly medical bill.
Furthermore, if you have an adequate emergency fund, you won’t have to dip into your long-term investments to pay for short-term needs. These investment vehicles, such as your IRA and 401(k), are designed for your retirement, so the more you can leave them intact, the more assets you’re likely to have when you retire. And because they are intended for your retirement, they typically come with disincentives, including taxes and penalties, if you do tap into them early.
However, as part of the economic stimulus legislation known as the CARES Act, individuals can now take up to $100,000 from their 401(k) plans and IRAs without paying the 10 percent penalty that typically applies to investors younger than 59½. If you take this type of withdrawal, you have up to three years to pay the taxes and, if you want, replace the funds, beyond the usual caps on annual contributions.
Of course, life is expensive, so it’s not always easy to put away money in a fund that you aren’t going to use for your normal cash flow. That’s why it’s so important to establish a budget and stick to it. When developing such a budget, you may find ways to cut down on your spending, freeing up money that could be used to build your emergency fund.
There are different ways to establish a budget, but they all typically involve identifying your income and expenses and separating your needs and wants. You can find various online budgeting tools to help you get started, but, ultimately, it’s up to you to make your budget work. You may be pleasantly surprised at how painless it is to follow a budget. For example, if you’ve budgeted a certain amount for food each month, you’ll need to avoid going to the grocery store several times a week, just to pick up “a few things,” because it doesn’t really take that many visits for those few things to add up to hundreds of dollars. You’ll be much better off limiting your trips to the grocery, making a list of the items you’ll need and adhering to these lists. After doing this for a few months, see how much you’ve saved—it may be much more than you’d expect. Besides using these savings to strengthen your emergency fund, you could also deploy them toward longer-term investments designed to help you reach other objectives, such as retirement.
Saving money is always a good idea, and when you use your savings to build an emergency fund, you can help yourself prepare for the unexpected and make progress toward your long-term goals.