Do You Need a Larger Emergency Fund in 2021?
You need emergency cash reserves at all times -- but should you boost yours this year in particular?
If there's one thing 2020 taught us, it's that having money in savings is extremely important. Millions of Americans lost their jobs or saw their income take a hit in the course of the pandemic. And while we can be hopeful that things will improve in 2021, let's face it -- we're not out of the woods just yet.
It will be months until a coronavirus vaccine is available to the general public, and the outbreak itself is still raging. That means more jobs could be lost as lockdowns and restrictions force businesses to lay off staff.
This is why you may want to aim for a higher emergency fund than usual this year. But let's talk about what that means.
How much money should you have in emergency savings?
As a general rule, it's smart to have three to six months of essential living expenses available in an emergency fund. The logic is that if you lose your job or get hit with an unplanned bill, you'll have a way to keep up rather than rack up debt.
By essential expenses, we're talking about bills you can't skimp on, including:
- Car payments
- Household essentials, like cleaning supplies
- Modest entertainment (if you're laid off, you can't spend months staring at a wall, so continuing to pay for a $15 streaming service is reasonable)
But given the state of the economy, it's not a bad idea to pad your emergency fund with enough money to cover one or two extra months' worth of expenses. Think about it -- unemployment is so rampant that if you were to lose your job today, it could take, say, five or six months to find work again. Under normal circumstances, it would maybe take two or three. As such, if you already have three months of living expenses in savings, aim for four or five months' worth. If you have six months' worth of bills available in cash, aim for seven or eight.
Remember, there's very little downside to erring on the side of a more robust emergency fund. It's true that savings accounts aren't paying much interest these days. As such, you could potentially earn a much higher return on your money by investing it instead. But you're also unlikely to lose out on all that much by keeping extra cash on hand for a year.
A big emergency fund gives peace of mind
Say you put an extra $3,000 into your emergency fund this year and it earns 0.05% in interest. That's $15. If you were to invest that money in stocks and generate an 8% return over a year (which is around what the stock market has historically averaged), that's $240.
On the one hand, an extra $225 is nothing to scoff at. On the other, it's not a life-changing amount of money for most people. If a larger emergency fund buys you extra peace of mind, it's worth losing out on a higher return for a bit. And to be clear, that 8% return isn't guaranteed; you could lose money on the stock market, too.
Another thing to keep in mind is that if you pad your emergency fund this year, you don't need to keep your extra savings once things improve. If the economy recovers by, say, September, you can take the extra cash you put into savings and invest it, or do something else with it. But on a temporary basis, you may want to consider boosting your emergency fund. At a time like this, a little extra financial protection could go a long way.
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