The Importance of Building a Long-Term Emergency Savings Account

by Guest

If you think about what you love to do with your money, what comes to mind?  Perhaps a guilty pleasure in the form of a Starbucks cup, a new piece of designer clothing, or perhaps it’s a weird hobby, like old electric trains.  The one thing most people never say they love to with money is save it.  And that is the reason so few Americans do it.

Prior to the 2008 Global Credit Crisis, personal savings rates in the United States were at all-time lows.  The personal savings rate is a figure that is calculated by taking a person’s income minus their essential expenses, which includes things like mortgages, food and gas, etc.  Then, whatever a person saves out of this remaining balance is divided by the remaining balance, and voila! you have an individual’s personal savings rate.

During the property market explosion of the 1990’s and 2000’s, homeowners experienced significant equity growth year after year on a consistent basis.  Therefore, saving expendable income became less attractive.  If a rainy day were to come, a person could simply tap into the massive amount of equity in their homes.  This casual attitude toward personal savings is what led the U.S. personal savings rate to finally hit all-time lows in 2007, just before the housing bubble popped.

In 2009, the story was quite different.  As a whole, Americans quickly realized that their homes were not the impenetrable investment they had thought they were.  Homeowners throughout America watched helplessly as the inflated equity in their homes was slashed by up to 30% in certain parts of the U.S.  This massive economic tsunami caused Americans to reconsider the importance of savings.  And by the end of 2010, personal savings rates in the U.S. were back at all-time HI’s not seen since World War II.

Why Long-Term Savings?

In 2008 and 2009, millions of Americans have lost their jobs.  When the housing bubble popped in ’08, capital flew out of risky investments such as the forex market, where traders buy and sell currency pairs like USD CHF.  In 2011, the unemployment rate is still at uncomfortably high levels above 9%, and this figure is not expected to fall sharply for some time.  In America, we are experiencing what economists call a “jobless recovery.”

The reality is that the probability of enduring a period of joblessness during one’s entire career is not as low as it used to be.  The question most of us need to consider is, how will we finance our living needs if we were unemployed for an extended period of time?  Trying to get into a risky business like real estate speculation or a forex course is not a good way to produce stable income in a time of economic hardship.

Most people would rely on one or a combination of four things:

  • Home equity
  • Retirement Savings
  • Credit Card
  • Personal Loan

Each of these options is dangerous, and number two and three are probably the most common choices.  If a person has to dip into retirement savings, that is putting one back several steps in the path toward financial independence, and the danger of financing daily living with a credit card is a mute point.

Thus, one of the primary reasons a long-term savings account is essential is because it will always be there when you need it.  Whether it’s a job loss, a large, unexpected hospital bill, etc, you will possess the peace of mind of knowing that there is a cushion for any financial hardships.  Funds from your savings account should not be used in forex trading.

Most personal finance experts agree that it is optimal to have at least 3 -6 months of living expenses saved up.  In the case of a job loss, that will cover a person for a solid 6 months on top of any unemployment benefits, and that will serve as a huge emotional strength during an otherwise tough time.

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krantcents February 23, 2011 at 9:29 am

I don’t have an emergency account! I don’t have any debt except for a small mortgage. I have a line of credit that only costs me if I use it for emergencies. I want my money working for me. I would not recommend this approach for everyone, but it works for me.

The Passive Income Earner February 23, 2011 at 1:42 pm

I agree with having a plan for emergency but enforcing a long-term emergency fund is like saying you need life insurance when you are 20 with no kids and such. It’s all part of having what makes you feel secure and it changes with your age and situation. Having the equivalent of 3 to 6 months salary is only needed when you chances of getting another job are low and you risk payments that you must pay. If you can adjust, it may not be needed.

I find that it is an oversold theory to keep 3-6 months salary but you need a plan for emergency! There is a limit to plan for disasters …

Kay Lynn February 28, 2011 at 5:36 am

@Krantcents , I keep a liquid small emergency fund but we have our larger “emergency fund” in an investment account.

@ Passive Income Earner, I think it’s good to have 3-6 months of salary somewhat easily accessible whether it’s in a savings account or investment account or ? Many people who thought they’d never lose their job did during the last recession.

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