Do You Have Enough Emergency Savings to Ride Out a Recession?
- A solid emergency fund could help you get through a recession.
- The amount of savings you'll need for full protection may be higher than what you previously thought it was.
It's a question worth asking in today's economy.
Right now, the U.S. economy seems fairly strong. After all, jobs are plentiful, and while inflation is soaring, that's actually a sign that consumers have money to spend.
But things could quickly take a turn for the worse. In an effort to slow down inflation, the Federal Reserve is implementing a series of interest rate hikes that are making it increasingly more expensive to borrow money.
Once borrowing becomes too expensive, consumers are apt to start spending less. And once a lot less money is pumping into the economy, it could set the stage for a period of widespread declines, complete with higher levels of unemployment.
It's for this reason that so many financial experts say you should assess your emergency fund now and make sure it's strong enough to get you through a recession. But does yours fit that bill?
How to assess your savings needs
When you contemplate the amount of money it'll take to get you through a recession, it pays to think more about your specific expenses than a specific dollar amount. In other words, rather than fixate on having $20,000 or $25,000 in savings, calculate your essential monthly expenses and then multiply that number by at least three, and, ideally, more like six to 12.
So, let's say you spend $5,000 a month on essential bills. For a six-month emergency fund, you'll need $30,000 in the bank. For a year's worth of living expenses, you'll need $60,000 in your savings account.
Keep in mind, though, that the amount you spend on essential bills may be higher now than it was a year ago. We can thank inflation for that.
So going back to our example, it may be that you used to spend $5,000 a month on essentials, but now you spend $5,500. If your goal is to have a six-month emergency fund and you have $30,000 in savings, it means you're actually a little short. Rather, you'd need $33,000 to pay for six months of expenses in the absence of having a paycheck.
Do you need a one-year emergency fund?
In the wake of the pandemic, some financial experts are advising consumers to have enough money in the bank to cover a full year of bills. While that's a great goal to achieve, it may not be doable for everyone. Plus, you may not need to save up enough to cover a full 12 months of expenses.
If you're a salaried worker and you lose your job in a recession through no fault of your own, you'll generally be entitled to unemployment benefits. Now those won't replace your missing paycheck in full, which is why you need your emergency fund. But they'll replace some of your missing income so that you only have to dip into your savings to cover part of your monthly expenses.
As such, you may decide you're comfortable with an emergency fund that can cover six months of bills. But again, you'll need to reassess your living costs, because chances are, your bills these days are a lot higher.
We can't say when our next recession will hit. Things could take a turn for the worse later this year or early next -- or maybe not. But at some point, a downturn is likely simply because that's the way the economy tends to cycle. And so it's a good idea to be prepared with adequate funds in savings -- whatever that means for you.
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