Today must be emergency fund day because earlier this morning I talked about how you shouldn’t rely on credit as an emergency fund ; now I’m going to remind you that you should adjust your emergency fund limits based on any changes in you or your environment.
Having an emergency fund is one of the cornerstones of a solid personal finance plan. Whether you subscribe to the three month, six month, or full year’s worth of expenses, an emergency fund is something that every single person and family needs. Emergency funds enable you to weather the difficult times, especially since they all seem to cluster together, without putting you in an even worse situation. Some people rely on credit cards to supplement the emergency fund and others will only rely on credit cards at the last moment, but ultimately you need to have an emergency fund that matches both your needs and the chance of a Bad Thing happening.
The first part of that last sentence is pretty well understood by people who have emergency funds. Most people are very aware of their own needs and how it affects their emergency fund. If you buy a house and have to service a mortgage, it’s clear that the emergency funds requires additional padding. If you have a child, most people recognize that the emergency funds need to be boosted to weather any additional crises that come with children. For those of you who understand risk analysis, the part people understand best is the impact or severity of a risk.
The part people are less cognizant of is the second part. In risk analysis, we’re talking about the probability (as opposed to the severity) of a risk occurring. Specifically, we’re talking about people changing their planning as the probability changes. For example, the onset of a recession increases the likelihood that you will be fired or laid off. While the severity of being fired remains the same (you lose the same amount of salary regardless of future he economic prognosis), the probability increases based on the economy and the industry you’re in.
So, how do you do this? Periodically sit down and re-assess your financial plans. Check out your retirement accounts, check out your bank statements, and check your emergency fund. Think about whether the environment has changed and whether you need to increase or decrease your emergency fund. Now, if you think a potential recession will increase the chances you’ll be fired, boost your emergency fund. You’re essentially self-insuring against being fired (and other negative events). As long as you recognize that the environment has changed and your emergency fund needs to as well, you’ll have done what you can to help weather any potential downturn. You can’t predict the future but you can at least prepare for it as best you can.