Financial experts recommend that you finance your living in an “emergency fund” for between three and six months, regardless of whether you are a private individual, a company or a real estate investor. You never know when you will lose your job or get sick or when a global pandemic will crash the economy. Relying on government benefits, charities, or family and friends may be necessary, but it’s not ideal. So how much emergency money do you need? Here’s what you should know.
According to a Bankrate poll, only 40% of Americans can afford an unexpected $ 1,000 emergency. And a CareerBuilder poll found that 78% live from paycheck to paycheck – and that includes 18% of those who make more than $ 100,000 a year, a report by Willis Towers Watson found.
Small businesses do even worse when it comes to emergency savings. A 2016 study by JP Morgan Chase found that “only half of all small businesses have a liquidity buffer large enough to cover 27 days of their typical outflows”. Another disheartening analysis reported on The Street estimates that “approximately 21 percent of all American small businesses will fail within 30 days of being quarantined.” (This is of course without government support.)
Large corporations are in the same boat. United and Delta Airlines used an average of 96% of their cash reserves to buy back their own stock instead of saving for a rainy day, a report from Bloomberg found.
However, sometimes it’s not even a strategy problem. Many successful investors feel that their money is “burning a hole in their wallet”. After all, that money could bring in a return!
Using the “money that burns a hole in the wallet” to “generate a return” is a stock buyback version for real estate investors – and we’ve seen how well that decision worked for airlines.
More on Disasters & Emergencies from BiggerPockets
What is an emergency fund?
An emergency fund doesn’t have to burn a hole in your wallet if you know what it is and how it can work for you without generating a huge return.
You need to be prepared for any emergency that could call for quick cash. Of course, you can’t predict every emergency before it happens. Still, when you have a comprehensive emergency financial plan in place that will enable you to handle almost any potential emergency that might arise, you can be prepared. This requires cash reserves for all individuals and businesses in an account that is easily accessible.
Real estate investors need an emergency fund when their tenants cannot or refuse to pay. At the end of the day, someone still has to pay the bank, and that falls to you.
Why You Might Need An Emergency Fund?
When you save money in a savings or checking account and put it aside in an emergency fund, you receive a grace at a time when you might otherwise make a desperate decision. If an emergency arises, you might be tempted to intervene in your retirement or other investment accounts to cover the costs. It also adds a safety net so that you don’t have to borrow more. The emergency fund can protect you now and in the future.
How much should you save for emergencies?
The size of your emergency fund will depend on your personal risk tolerance, the types of emergencies you are most likely to face, and your personal circumstances (including your income). A good rule of thumb, however, is to set aside spending of at least three months, and preferably six months or more. You need to know how much you are spending in a typical month and plan to cover at least three months to be on the safe side. Your savings goal can be more or less months, depending on your lifestyle and profession.
What monthly expenses should you consider when calculating your minimum emergency fund amount? Make sure you include any mandatory payments such as credit cards, mortgages, rentals, or student loans. (Some loans can be deferred in an emergency, but it is better to be prepared.) Also consider things like utilities, groceries, phone bills, and other mandatory monthly expenses. But discretionary expenses like eating out should be greatly reduced in an emergency – so you don’t necessarily have to save enough money to cover your usual restaurant bills. Remember that in an emergency, your spending habits will change, hopefully dramatically!
It’s also important to appreciate your home repairs. Most experts recommend that homeowners save about 1% of the total value of their home for the estimated repair and maintenance costs of their home in any given year. For example, if you live in a $ 250,000 building, budget about $ 2,500 in annual repairs. This can increase or decrease depending on the age and condition of your home.
If possible, try to avoid emergencies before they occur. Invest in solid insurance policies that will protect you from most of the unplanned expenses you would otherwise incur. Take care of your home with upgrades and repairs as needed. Attend regular medical examinations and keep your vehicle in good running order.
For investors, the economies of scale concept is worth mentioning. For smaller properties with only one or two units, a six-month cash reserve per unit is appropriate. But as the lot size increases, it is probably not worth saving six months for each unit. The likelihood that each unit will be vacant or hit by a non-insurance-related emergency at the same time is slim.
Are you ready to invest?
One of the most frequently asked questions on the BiggerPockets forums is, “How can I invest in real estate with no money and bad credit?” The answer? They should not. You need to get your situation in order and invest from a position of financial strength.
Where should you invest your emergency fund?
You should keep your emergency fund in a safe place where you can easily access it. Most mainstream banks are federally insured for up to $ 250,000 (and sometimes more), making this one of the safest options. However, low risk means lower interest rates, so don’t expect big returns. Having 2% interest on your Emergency Fund savings account is great for making sure your money is instantly available when you should need it.
When should you use the money?
It is important to only use this money for an emergency that you otherwise cannot pay for.
You should be prepared for a variety of financial emergencies, including:
- Collisions with vehicles. Ideally, the person who caused a traffic accident will cover all damage with his insurance and you can go on with your life as if nothing had happened. You could be the victim of an accident – but you could run into insurance problems or suffer a debilitating injury that prevents you from doing your job. Legal action can help you recover your expenses, but it will take some time to resolve intermittent liquidity bottlenecks.
- Injuries and illnesses. You never know when you or a loved one will fall ill and become unable to work. Here, too, you need an emergency fund to cover uninsured expenses and to compensate for the loss of wages at short notice.
- Major repairs to the house. If your roof starts to leak, you need to repair it ASAP. Some home problems can make your home uninhabitable, and others will only get worse the longer you don’t let them address you.
- Natural disasters. Insurance covers many natural disasters, but you may find that certain specific expenses are not included or that your insurance plan does not reference certain disasters.
- Job loss. Even if you are great at your job, you may be fired or otherwise disabled. You also need to be prepared for this type of loss of income.
It is important for real estate investors to keep these emergencies in mind in each of their units. Repairs, natural disasters, and rental losses are financial emergencies that you should be prepared for.
That’s not to say that you should magically have cash. Maintaining strong cash reserves should be an integral part of your business plan. It should be something to build on.
Try to have around 5 to 10% of your assets in cash or cash equivalents. As your real estate investments grow and spreading across more properties dilutes your risk, that percentage could go down a little. Still, as these financial experts recommend, aim to have between three and six months of basic expenses in reserve for you and your business.