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Posted: July 12, 2012

Seven essential financial questions: No. 3

Do you have an emergency fund?

Michael Hood

(Editor's note: This is the third of a seven-part series.)

I have created a basic financial planning process using Seven Essential Questions as the foundation. Why only seven?

The answer is simple. I have conducted thousands of planning meetings over the past twenty years and have discovered that while most people know they should have a financial plan, they are often overwhelmed by the thought of even starting to create one. It seems like something that will take many hours and be painful or boring. I find that by breaking down the process into answering these Seven Questions, we are able to build a framework for a financial plan that is comprehensive, yet simple enough to implement.

Essential Question #3: Do you have an emergency fund?

We all experience unforeseen financial bumps in the road. An emergency fund ensures there is money set aside for them. Without an emergency fund, using a credit card is usually the only solution. This can lead to credit card balances that cause many people to feel as though they can never get ahead and saving for the future becomes impossible.

According to most financial planning textbooks, an emergency fund should have an amount equal to three to six months of your normal spending. Keep in mind that emergency funds are not slush funds. Think of the emergency fund as the financial fire department, whose job it is to be ready when some unexpected financial emergency arises.

Once your emergency fund is in place, it is not uncommon for it to go many months with no activity. Once you have the minimum (three months’ spending) emergency fund established, then you can begin to save for upcoming projects in the project fund.

I prefer to keep the emergency fund in a separate savings account at a bank or in a money market, not at the bank where I do my regular checking. This makes tapping into the emergency fund enough of a hassle that it helps provide the discipline to leave it alone.

Key concepts:
1. Financial emergencies happen.
2. A minimum emergency fund is an amount equal to three months of spending.
3. The emergency fund is used for genuine trouble, not discretionary spending.
 

Michael Hood, CIMA®, is a Certified Financial Planner™  and First Vice President of Wealth Management for Morgan Stanley Smith Barney in Denver. He can be reached at 303-925-9648 or michael.j.hood@mssb.com. Visit his website at http://fa.smithbarney.com/hood.

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