Benjamin Franklin once said, “Beware of little expenses. A small leak will sink a great ship.”
It’s common in retirement planning to focus on the big expenses we know will hit at some point. The expenses that come with travel. The expenses that come with medical care. The expenses that come with daily living. But there are plenty of potential “leaks” that can scuttle even an airtight retirement. A tree falls on your garage during a storm and the roof caves in. The car windshield gets so cracked it has to be replaced…the same week you were planning on replacing the tires. A family member gets sick while on vacation…forcing you to pay to fly them home ahead of schedule. You get the idea.
These unexpected expenses, especially when they pile up in a short period of time — because after all, when it rains, it pours — can scuttle your retirement plans in a hurry.
That’s why every pre-retiree should have an emergency fund.
What is an emergency fund? Generally, this is defined as having enough liquid assets to cover three-to-six months’ worth of emergency living expenses. In case of financial emergency, access to additional money will save you from having to rely on credit cards or loans. After all, being in debt can sometimes be its own emergency — and not one you want to experience in retirement.
When starting an emergency fund, here are a few tips to consider:
Determine what amount is best for you.
Most experts agree that you should keep between three- and six-months’ worth of your living expenses set aside in your emergency fund. Your specific situation—whether you have children, carry substantial debt, and types of insurance coverage you have—will determine what amount is best for you. Examine your situation, your income, and your needs to decide how much you should save.
Start small. Starting an emergency fund can be as simple as depositing $100 every month into a savings account.
Also, bear in mind that this savings account should be a separate account, unrelated to whatever you use for daily expenses. That way, you’ll be less tempted to use the money for something other than what it’s meant for.
Stick to a schedule.
Get into the habit of making regular deposits. Whether it is weekly, bi-weekly, or monthly, create a schedule and stick to it. Once you make saving automatic, you won’t even have to think about it.
Allocate a portion of your tax-refund.
Most people tend to treat their tax refund as a windfall for spending, but if you set aside even as little as 5 or 10% every year, you will be creating an enormous safety net for yourself.
Define what an “emergency” means for you.
Does replacing the transmission on your car count? What about that midnight call to the plumber? Generally speaking, an emergency fund can be used for expenses that come as a surprise that might affect your health or basic needs. On the other hand, it shouldn’t ever be used for expected expenses, like buying groceries or paying for health insurance. And it should never be used for mere “wants.” Making a list now of what your emergency fund is, will serve you well in the future.
