Just 39% of Americans could cover an emergency expense costing $1,000, per a 2021 study by Bankrate. The other 60% would be up the creek without a paddle.
Because emergencies do happen, and not just to other people, either. Three out of ten Americans say they or an immediate family member faced an urgent and unexpected bill last year, such as an emergency medical expense, home repair, or car repair.
Nor are they cheap: of those unexpected bills, over a third (36%) cost more than $5,000. Another 41% cost between $1,000-$5,000, and only 18% of these unexpected bills fell under $1,000. (For the math jocks out there who point out that those numbers don’t add up to 100%, a small percentage of respondents either didn’t know or didn’t answer the question. Don’t be a smarta$$.)
All of which raises some serious questions about how much of an emergency fund you should have. Here’s what you need to know about emergency fund amounts, how to save for an emergency fund, where to hold it, and why you especially need an emergency fund as a real estate investor or property owner.
Emergency Fund Definition
I hate to break it to you, but your stocks are not an emergency fund. Or at least they shouldn’t be.
An emergency fund is a source of stable, liquid assets that you can immediately draw on in a (you guessed it) emergency. If you can’t get to it quickly, painlessly, and risk-free, it’s not an emergency fund; it’s an investment.
Emergency funds must be easily accessible, with no risk of major losses by tapping into it. Long-term investments, such as stocks and real estate, are either too volatile (in the case of stocks) or not liquid enough (real estate) to serve as an emergency fund.
Your retirement account is not an emergency fund either — beyond the volatility of the investments in it, you’ll incur tax penalties if you withdraw money early.
How Much Emergency Fund Should I Have?
Like most questions worth asking, the answer is “It depends.” The more variable your income and/or expenses, the greater your emergency fund should be.
In the personal finance world, advisors typically measure emergency funds by the number of months of living expenses you can cover with it, rather than total dollar amount, once you surpass a minimum threshold like $1,000.
For example, if your monthly expenses total $4,000 a month, and you have $6,000 in your emergency fund, then you have 1.5 months’ expenses.
Is that enough? Too much? A person with neat, tidy, regular income and expenses doesn’t need as deep of an emergency fund amount as their less-predictable neighbor. With a biweekly paycheck and stable expenses, a cash emergency fund of 1-3 months’ expenses is usually sufficient.
For someone with highly irregular income, such as a full-time real estate investor, that’s not enough. They may go five months with no paycheck, followed by a $50,000 payday after flipping a house. People in this position should keep 3-6 months’ expenses in an emergency fund, maybe more, because they can’t count on a regular W2 paycheck.
Likewise, someone with irregular expenses (like landlords!) need a larger emergency fund. Even if you have a regular income, you need a larger emergency fund if your expenses vary month-to-month.
Property Owners Need Emergency Funds for Each Property
Remember how real estate cash flow works?
You have to calculate the long-term average of large-but-irregular expenses. That distinction between your “typical” expenses and your “average” expenses is lost on many new landlords, and they lose money accordingly.
In a typical month, your only expense is the mortgage payment and maybe property management fees. But that doesn’t mean you can ignore irregular expenses like vacancy rate, repairs, maintenance, accounting costs, property taxes, insurance (including rent default insurance), and so on.
You may get hit with a $3,000 HVAC repair this month, followed immediately by a $10,000 roof replacement bill the next month. Another property may suffer a vacancy, or worse, require that you start the eviction process, with no income for months while you make repairs, repaint, collect rental applications, run tenant screening reports, etc.
Every single property needs its own private emergency fund, where you set aside a percentage of each month’s rent payment. Contact Wiese Properties Inc. Team to calculate your needed reserves – and then be disciplined about setting aside the money each month.
The same goes for homeowners. While you may not need to set aside money for vacancy rate or bookkeeping costs, you can still expect irregular repair bills that renters don’t face. You need a heftier emergency fund to compensate for that irregularity in your expenses.
Where to Keep an Emergency Fund
If you shouldn’t park money for an emergency in your retirement accounts, stocks, or illiquid real estate investments, where should you park it?
Your emergency fund should sit in easily-accessed savings accounts, money market accounts, or short-term investment accounts you can tap instantly. It should also be FDIC-insured, unlike your investments.
Look for the highest-return account that you can find, with no early withdrawal penalties if the worst happens tomorrow. Some online savings accounts and money market accounts offer interest up to 2% or even 2.5%, but be sure to read the fine print. They often include minimum balance requirements, and may charge a penalty if you pull money out within the first six months or year.
Ideally, you want to keep your emergency fund in a separate institution from your checking account. Out of sight, out of mind, so you aren’t tempted to tap into it to buy that new jacket you’ve been eyeing.
Layering Your Emergency Fund
If you spend $5,000 every month and want to keep six months’ expenses in an emergency fund, that’s $30,000 — an awfully high amount to keep in cash. The opportunity cost of letting that much cash collect dust is more than some investors can stomach.
The answer? Layer your emergency fund.
Start with a certain amount in cash, in a high-interest savings account. In this example, we’ll say that you keep one month’s expenses ($5,000) here, accessible at a moment’s notice.
Then, let’s say you put another two- or three months’ expenses in a stable short-term investment. That could include a government bond fund or a liquid real estate crowdfunding investment such as Concreit or Stairs by Groundfloor. You can earn more than in your high-interest savings account, with stability and liquidity.
For the remaining amount, consider a credit line that you can tap into in a truly dire emergency. It could be an unused credit card that you set aside for emergencies, or a HELOC, or some other rotating line of credit. (Word to the wise: you can borrow HELOCs against rental properties, not just your home.)
The important thing is that you never use it, leaving it for emergencies only.
That way you don’t leave your entire emergency fund languishing in a savings account, not working for you, but you still have plenty of options to draw money in an emergency.
