One of the things that many people do not do when considering their emergency fund is how much risk they have. They may have thought of the chances of being laid off from their job in determining how much to save, yet typically nothing more. We have relied on the rule of thumb of having 3 to 9 months set aside for an emergency fund. However, we never really thought if 3 to 9 months is really enough for what an emergency fund should cover.
Some of the risks that we should consider for an emergency fund are:
Age – The chances of being disabled increases with age. Also, even though age discrimination is not permitted, it is sometimes more difficult for older workers to get hired for certain jobs if they find themselves unemployed. It may not be age discrimination necessarily; however, an employer may use potential to decide which of two equally qualified applicants to hire. If one applicant’s potential may not been fully realized where the other applicant with more experience may have shown his full potential already (given more chances to succeed yet has not done so), the one with more potential may be given the nod. If a company had too many employees with no potential for growth, they are stuck in the mud because it is hard to promote within. Contrary to what we think, companies want to promote within because they have seen their employees in action and it is risky to hire someone based on a resume and short interview process. Thus, the potential for future growth is sometimes given preferential treatment over experience in the hiring process especially in lower and middle level positions.
Education – The probability of being unemployed at a point in time being a college graduate is ½ the risk of a high school graduate (per College Board – 5.4% for high school graduates versus 2.3% for college graduates). Sometimes having a college education gets someone in the door even if their degree has nothing to do with the job criteria. Some employers may see the college degree as a sign of determination and ability to learn on the job and thus give college graduates preferential treatment in the hiring process.
Job Skills – The more flexible your skills are, the more opportunities you have to switch careers. If you are a pianist who is starting to develop arthritis, it is hard to transfer your skills other professions other than being a piano teacher. The skills I used as an actuary in a consulting field has allowed me to do many different things down the road because I did a little bit of everything as an actuary from accounting, economics, investing, legal, speaking, etc. as a part of my job. Thus, the more skills you have, the more opportunities you have open up if you need to change careers. In today’s world, many people will have more than one career thus flexibility is a key to reduce risks of being unemployed.
Job Market – If you are a nurse in today’s economy, it is easier to find another job than some other professions. For example, if you work in the car manufacturing field, the opportunities are more limited where changing jobs if you are laid off it much tougher and may take a longer time to find another job. Therefore, you may want to have a larger emergency fund.
Economy – Many people think when the economy is booming that there is little need to have a large emergency fund because they could always get another job easily. However, the economy tends to change with little warning. With companies being more careful about watching costs, they can turn their hiring forecasts around within the matter of months. Thus, even if the job outlook is great now, in 6 months it can easily change.
Living Expenses – If you have a lot of fixed expenses (mortgages, car loans, cell phone contracts) where it is hard to cut anything, you are at greater risk than someone who has mostly fixed expenses that can be cut instantly (like vacations, eating out, entertainment, etc.). The more we can and are willing to cut the less of an emergency fund we may need.
Insurance (Disability & Medical) – We know about the risks of becoming disabled and not being able to work as a reason we need an emergency fund. Just realize that even if you have a good long-term disability insurance polity, the policy will typically not cover 100% of your lost income (typically 60% to 80% of base income) because if they did there would be no incentive to go back to work. Also, needing an emergency fund to pay large medical expenses is also important. Thus, if you have a plan that has high deductibles and no cap on co-pays (e.g. 20% on all expenses even above $5,000), you may need to have a larger emergency fund in case of an accident or illness.
Also, everyone talks about 3 to 9 months of living expenses and thinks about their current expenses. However, what many people forget about is covering the cost of COBRA (health insurance) while unemployed. Many are unaware of the cost until their ex-employer offers to continue their medical insurance at 102% of the actual cost to the company (cost of insurance plus 2% for administration expenses). This is significant because many of us do not even consider the part of our health insurance that we already pay because it is taken automatically out of our paycheck. I have heard too many people say that they were not able to pay for health insurance, so they went without insurance and are now struggling with debt due to having a medical condition diagnosed in the meantime. If you are unsure how much health insurance will cost to cover your family, many employers are listing the full cost in their annual benefit election material or their annual summary of benefits. If it is not there, you can always ask your HR representative.
Family Situation (changes like having a baby) – Many people do not think ahead of some additional expenses that they may have when having a baby. We think about the cost of getting the car seat and baby furniture. However, many do not factor in if there are complications with the delivery. Not only could they have significant medical costs but also they could have a loss of income due to being confined to extended bed rest or needing to be in the hospital with their baby after a premature delivery or other complications. Many first time parents spend more time thinking about taking their last vacation BC (before children) than thinking about saving a little bit more just in case something happens. The unexpected costs are not only with children but also with elderly parents where adult children may need to take off for an extended period of time to take care of the parents or pay for a nursing home.
Single Income – Some feel that it is more risky being a dual income family than a single income family because if one spouse is laid off or become disabled in a single income home, the other spouse could go back to work. This may or may not be true depending on their spouse’s employment background. A spouse that stays at home to raise their children may be out of the workforce for a long period of time that it takes a while to get back into the workforce and when they do it is usually at an entry level especially after a prolong break (needing to prove their abilities all over again). Thus, it is true that there may be some reduction in risk because the other spouse can re-enter the workforce to replace the single earner’s salary. Yet, it is probably going to be at a fraction of pay and may take weeks and maybe months to happen. Thus, sometimes there is less of a risk being a dual income family because you may lose 50% of the total family income, yet it is better than 75% reduction of a single income family’s income, especially if the spouse working has a high paying job (such as a manager or physician) compared to the spouse who goes back to work to fill in the gap. In addition, dual income workers, tend to have higher flexible expenses such as eating out, dry cleaning, maid services, etc. that can be cut back on if one spouse now is temporarily at home and has more time to do these chores instead of hiring someone else to do it for them.
Medical History – If you are not as healthy as others or your family history shows some tendency for a medical condition (such as heart condition or cancer), you may want to be better prepared in case something happens.
Paid by Commission instead of Salary – If you are paid by commission, it is better to have a larger emergency fund in case there is a drop off in sales due to a cooling economy or a new product that enters the market place and takes away some of your business.
Self-employed – Some say that being self-employed is less risky than being employed by a company where you are at risk of being fired. However, in my mind being self-employed is riskier because you are still at risk of getting fired by your clients (instead of by a company). Yet, at a company, if you are fired, you can claim unemployment, something that is not the case if you are self-employed (can’t fire yourself). In addition, being self-employed, you ride the waves of clients coming and going (similar to being paid on a commission basis). In being employed by a company on a salary, the company insulates you to an extent by providing a fixed income. In addition, if you are better than the average employee, you are a somewhat insulated from being fired at the first signs of a business downturn (unlike being self-employed).
Thus, when you are considering how much to save in an emergency fund, look at all your risks, not just the chance of being unemployed. Those who are better prepared in an emergency have a better chance at getting out quicker because they can focus on the problem and not trying to scramble for cash to pay the bills.