Dave Ramsey takes a lot of heat from financial professionals, but his seven steps have helped millions of people pursue a better life. I don’t agree with his entire philosophy, but establishing an emergency fund, paying off debt, and saving for retirement are tenants that make sound financial sense.
During challenging times, an emergency fund is paramount. I recently bought a new refrigerator, and my Jeep needs an engine repair. Thankfully, I have an emergency fund to cover the costs. If I didn’t have the fund, I would have charged the expenses to my credit card, and a credit card is not an emergency fund!
Stocks and bonds are down sharply. The S&P 500 has dropped 21%, while long-term bonds have fallen 26%. It’s difficult for investors as all major asset classes are in negative territory, and cash is the best-performing asset. If cash is your best investment, you know it’s a tough year! However, a significant cash balance allows your stocks and bonds to recover, and that’s why an emergency fund is necessary if you want to be a successful investor.
What is an emergency fund? Well, it’s a fund you can tap in an emergency, so you’re not forced to sell stocks or bonds when they’re down. The fund is a liquid resource you can tap at any time without losing money. Your emergency fund should own cash, money market funds, CDs, or T-Bills. A silver lining to rising interest rates is you can buy short-term investments with competitive yields. The 1-Year Treasury rate currently yields 3.15%; two years ago, it was 0.14%, an increase of 2,150%!
Here are a few suggestions for establishing your emergency fund.
- Invest in short-term instruments like cash, money market funds, CDs, and US T-Bills.
- Your emergency fund should cover nine to twelve months of expenses in the current environment. For example, if you spend $10,000 monthly, your fund value range would be $90,000 to $120,000.
- Ladder your emergency fund with CDs or T-Bills maturing monthly: one month, two months, three months, etc. The short-term maturities provide liquidity when you need it most.
- Automate your savings so you don’t have to think about investing monthly.
- Don’t use Bitcoin, stable coins, credit cards, or a line of credit as a substitute because they can lose value or get terminated by your bank. During previous recessions, banks curtailed credit, and it wasn’t easy to get a loan.
Markets always recover as they did in 2020, 2018, 2016, 2008, 2000, etc., and an emergency fund allows your stocks and bonds to rebound. Cash is valuable, especially when the economy and markets are imploding.
An emergency fund turns a crisis into an inconvenience. ~ Dave Ramsey
June 15, 2022
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
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