I am often asked about the concept of setting aside funds for a variety of reasons and with a whole host of goals and objectives. Often, the reasons fall into two primary categories: expected but irregular large expenses, and emergencies or significant changes that are unforeseen. The first category might comprise things like roof repair, a major vacation, or replacing a car, while the second category could be a result of loss of job, divorce, or other unanticipated events that might require access to a meaningful amount of secure funds. Regardless of the reason for setting up the account and the eventual goal for the funds, I have found that this practice is not only sound financially, but it can give a peace of mind that soothes the anxiety of the curveballs that life will, inevitably, throw your way.
If we are in agreement that setting funds aside for these possible/potential events is important, the next question is – how much? Our industry is trained to answer that question with… it depends. However, I know how unsatisfying that answer is, so let’s at least frame an answer that might be more helpful (even though, “it depends” is actually correct). A standard line of thinking goes: set aside 4-6 months of living expenses (full living expenses) for the substantial unforeseen changes and then use a basic “all-in” calculation for the expected but irregular expenses. For example, if your standard monthly expenses run about $10,000 to $12,000 per month, then 6 months would be between $60K and $72K just to cover that portion. Add to that a running list of open items that might come up sooner rather than later (e.g., HVAC replacement, major car repair, big vacation, etc.), and the total fund might look more like $100K to $120K. Another caveat that is helpful is to ask – is that amount large enough to make me sleep well at night? In other words, in order for these funds to do their job, it has to be enough that you really understand that it will cover most (maybe all) of what might come your way.
Lastly, and this is where clear goal-setting and communication is critical, it is our job as your investment advisor to think about how to invest these funds. Keep in mind, these are funds that really need to be there when needed. Also keep in mind that they are still invested assets and should have some element of return on investment. So, if the goal is liquidity (i.e., when needed, you can access) and low downward volatility (the value of the account should not fluctuate much) and this is agreed upon, then the funds will be invested with that goal in mind. This is true for all accounts and all funds but particularly so for funds that are set aside for emergencies, rainy days, or just a margin of safety and comfort. Once the account is set up, funded adequately, and invested properly… you should enjoy a good night’s sleep!
