By Chia-Li Chien
The government shutdown took a toll on furloughed employees and government contractors, reminding us all of the need for financial emergency preparedness.
According to a 2015 study from the Pew Charitable Trusts, the median cost of a financial emergency is $2,000, or half of a typical monthly income. The study found that the median household had less than $4,000 in liquid savings.
There are so many reasons that families face financial emergencies. The Pew study defined “financial shock” as an irregular deficit that reduces income such as car and home repairs, fluctuating work hours, pay cuts or health emergencies not covered by insurance. Although these situations do not happen often, one setback could result in a long recovery time for a family.
Like many families out there, my family delays any type of house repair until it’s necessary. Last summer, our 14-year-old air conditioner stopped working. We had gotten quotes from Costco and other local firms the previous year, but my husband wanted to go to his guy.
Our financial shock was $10,000 cash because his guy was a small firm that didn’t provide any financing. I had a stash to take care of events like this, but it was still painful because I was relocating to California for a tenured-professor job at the same time. We had to pay for all the moving expenses before the university reimbursed us for a portion of them.
Pew’s research found that 19 percent of the respondents took more than six months to recover. Higher-income families have higher financial emergency costs, but it took three times longer for lower-income families to recover.
It only took my family two months to recover the emergency funds, but it was not easy emotionally. Because we were too accustomed to a particular lifestyle, the feeling of not having my emergency fund in full was stressful. But our income was not reduced like the federal employees and contractors. Many of these families had to take out a loan just to make ends meet.
The rule of thumb is an emergency fund between three- and six-months’ salary depending on income level. The number of months’ salary that should be in an emergency fund depends greatly on your ability to land another job.
The higher up your position and the older you are, the longer it takes to land your next job. I recommend the following guidelines:
• Business owners who have less than $1 million in revenue should save up to six months after-tax salary. In your company, have at least three months’ worth of business expenses.
• Owners who have between $1 million and $5 million in revenue should save up to 12 months after-tax salary plus six months’ worth of business expenses.
• Rank- and-file employees older than 45 must save six months after-tax salary. If you’re younger, you might get by with a three-month emergency fund.
Having an adequate emergency fund and other types of liquid accounts should enable you to recover from small or big financial shocks and cushion the associated emotional stress. I was stressed having to pay for the AC, but I knew that I would save up the emergency fund again soon — which I did. I find that families that have diligently saved up for the emergency fund are also well prepared for an unexpected financial downfall. Additionally, they are good savers for retirement and other investments.
No one will take care of you except you, and you must have enough emergency funds to meet any unexpected financial shock.
• Chia-Li Chien is the director of the financial planning program at California Lutheran University.