1 of 28

Preparing for Financial Emergencies

Financial Security Series

2 of 28

Your Instructor�Kirk Okumura, MSFS, ChFC®, RICP®

Program Director for the Financial Services Certified Professional® (FSCP®) program.
Financial planner and office manager for 4+ years for an independent RIA.
Over 25 years in the financial services industry in education and training.

3 of 28

Learning Objectives

Objective 1

Describe the benefits of having an emergency fund.

Objective 2

Assess the size of your current emergency fund.

Objective 3

Estimate the amount of the emergency fund you need.

Objective 4

Map out a basic emergency fund plan.

After you’ve completed this module, you will be able to:

4 of 28

Learning Objectives

Objective 5

Address common challenges to creating an emergency fund.

After you’ve completed this module, you will be able to:

5 of 28

What Is an Emergency Fund and Why Do I Need One?

Describe the benefits of having an emergency fund.

1

6 of 28

What Is an Emergency Fund?

Cash Flow				Assets and Liabilities
Month	Income	Expenses	Net Cash Flow	Assets	Liabilities
Jan	$4,000	$4,000	$0	$0	$0
Feb	$4,000	$4,000	$0	$0	$0
Mar	$4,000	$5,200	($1,200)	$0	($1,200)

An emergency fund is liquidity available to cover an unexpected, necessary increase in expenses and/or unexpected decrease in income.

Meet Aaliyah. She has a take-home pay of $4,000 per month. However, she spends everything she makes. Here is her cash flow, and her assets and liabilities for the first two months of the year.

[CHANGE IN PICTURE]

Unfortunately, Aaliyah had a twelve-hundred-dollar car repair in March.

Without any savings, she has to pay the bill with her credit card.

She now has a $1,200 credit card balance, paying 15 percent interest. Not only is she worse off financially, she’s also feeling stressed out because of it.

[TEXT APPEARS]

What Aaliyah needed is an emergency fund, which is liquidity available to cover an unexpected, necessary increase in expenses and/or unexpected decrease in income. Most of the time, an emergency fund consists of cash or near cash assets because you need to know it’s going to be available at a moment’s notice.

7 of 28

Which of the following events meet the criteria of unexpected and necessary increase expense or unexpected decrease in income?

A get-away cruise to the Bahamas
Regularly scheduled auto maintenance
A loss of income due to a disability
A root canal to cure a tooth ache
A broken refrigerator
A clothing sale
A veterinarian bill for a sick pet

Which of the following events meet the criteria of unexpected and necessary increase expense or unexpected decrease in income?

A get-away cruise to the Bahamas
Regularly scheduled auto maintenance
A loss of income due to a disability
A root canal to cure a tooth ache
A broken refrigerator
A clothing sale
A veterinarian bill for a sick pet

To understand what an emergency fund is for, it’s important to focus on the criteria of “unexpected and necessary” for increased expenses and “unexpected” for decreases in income. Which of the following events meet the either unexpected and necessary expense or unexpected decrease in income?

Review answers

A get-away cruise to the Bahamas <This is not an emergency because it is unnecessary.>
Regularly scheduled auto maintenance <This is not an emergency because it is expected. For example, maintenance on a car at 100,000 miles should be planned and saved for in advance.>
A loss of income due to a disability <This is an emergency. It is generally unexpected.>
A root canal to cure a tooth ache <This is an emergency. A tooth ache usually is an acute situation and fixing it a necessity.>
A broken refrigerator <This is an emergency, although one could argue that if you have an old refrigerator, you should be setting money aside to replace it.>
A clothing sale <This is not an emergency. It is unexpected, but generally, not considered unnecessary.>
A veterinarian visit for a sick pet <This is an emergency.>

8 of 28

What Is an Emergency Fund?

High-interest Debt

Taxes and Penalties

Stress and Anxiety

You can avoid…

How important are these benefits to you?

9 of 28

What Is Your Current Situation?

Assess the size of your current emergency fund.

2

10 of 28

What Is Your Current Situation?

	Current Amount	Target Amount	Surplus/ (Shortfall)	Account
Tier 0: Cash at Home (in a safe)
Tier 1: Savings, High-yield Savings, etc.
Tier 2: CDs, Treasury Bills, etc.
TOTAL TIERS 0-2:
Tier 3: Other Sources of Liquidity

$ 300

$ 1,000

$ 0

$ 1,300

We will use the following table to keep track of your resources. Don’t worry about the tiers for now. Also, only include monies you would use for an emergency situation.

Total up the cash you have on hand for emergencies stored in a safe or other secured location in your home. This does not include money in your wallet! Enter the amount in the Tier 0 space in the Current Amount column.

[TEXT APPEARS]

We’ll use $300 for our example.

Next, add up all the money in savings accounts, including high-yield savings accounts, and money market accounts immediately accessible through an ATM or an electronic funds transfer request, without fees or penalty. Include any excess funds in your checking account above any buffer amount to protect against overdraft. Enter the amount in the Tier 1 space in the Current Amount column.

[TEXT APPEARS]

$1000 for our example.

Finally, sum up money in certificates of deposit, Treasury bills, and any other monies that would have delays, fees, and/or penalties in accessing them. Enter the amount in the Tier 2 space in the Current Amount column.

[TEXT APPEARS]

For this example, we have nothing.

Add up all the amounts in Tiers 0 to 2. Enter the amount in the Total Tiers 0-2 space in the Current Amount column. This is your current basic emergency fund.

[TEXT APPEARS]

In this example, the basic emergency fund is $1,300.

11 of 28

How Much of an Emergency Fund Do You Need?

Estimate the amount of the emergency fund you need.

3

12 of 28

How Much of an Emergency Fund Do You Need?

Emer-gency Fund Size

Monthly Base Amount

Number of Months

Monthly Expenses ̶ Other Reliable Income

Monthly Base Amount

13 of 28

How Much of an Emergency Fund Do You Need?

Emer-gency Fund Size

Monthly Base Amount

Number of Months

Monthly Take-Home Pay $ 3,325.21

+ Health Insurance Premiums + 250.00

– Monthly Savings – 200.00

Monthly Base Amount $ 3,375.21

Monthly Expenses

Option 1: Living Expenses Approach

[TEXT APPEARS]

One option for estimating monthly expenses is the Living Expenses Approach. If you track your income and expenses, create a cash flow statement and total up your monthly expenses.

[TEXT APPEARS]

Otherwise, here’s a shortcut method to use. With the shortcut method, assume you spend everything you don’t save.

Take your average monthly take-home pay. In our example, we’ll use $3,325.21.
Add back in estimated health insurance premiums because you are still going to need to pay for health insurance. In our example, we’ll use $250.00.
Finally, we’ll subtract any monthly savings, which includes retirement savings and any other savings you’re doing. We’ll say $200.00.
In this case, the monthly base amount is $3,375.21. This is the estimated monthly living expenses after income taxes and savings.

14 of 28

How Much of an Emergency Fund Do You Need?

Emer-gency Fund Size

Monthly Base Amount

Number of Months

Monthly Take-Home Pay $ 3,325.21

+ Health Insurance Premiums + 250.00

– Monthly Savings – 200.00

– Reduction to Mo. Discretionary Exp – 225.00

Monthly Base Amount $ 3,100.21

Monthly Expenses

Option 2: Essential Living Expenses Approach

15 of 28

Select the expenses that would usually be considered nondiscretionary expenses.�

Health insurance
Vacation
Auto insurance
Real estate/property taxes
Dining out at restaurants
Gym membership

Debt repayments
Rent/mortgage
Water, electric, heat
Gifts
Entertainment
Food

Health insurance
Vacation
Auto insurance
Real estate/property taxes
Dining out at restaurants
Gym membership

Debt repayments
Rent/mortgage
Water, electric, heat
Gifts
Entertainment
Food

If you are using the essential expenses method, it’s important to be able to identify discretionary expenses you can cut. Which of the following would be classified as a discretionary expense?

Health insurance—nondiscretionary, a hospital stay could run tens of thousands of dollars without health insurance
Vacation—discretionary, you can live without one if you had to
Auto insurance—nondiscretionary, assuming you have a car and drive to work
Real estate/property taxes—nondiscretionary, not paying real estate taxes will jeopardize your home
Dining out at restaurants—discretionary, buying groceries and preparing dinners is a cheaper option
Gym membership—discretionary for most people
Debt repayment—nondiscretionary, not repaying your debts will harm your credit score
Rent/mortgage—nondiscretionary, you need a place to live. Of course, you could pursue options with a lower rent or mortgage.
Water, electric, heat—nondiscretionary, utilities are necessary for preparing food, staying alive, and so on
Gifts—discretionary, most people will understand if you lost your job
Entertainment—discretionary, definitely less important than having a place to live and keeping the lights and heat on
Food—nondiscretionary, you need food to live

16 of 28

How Much of an Emergency Fund Do You Need?

M

Emer-gency Fund Size

Monthly Base Amount

Number of Months

Rule of Thumb:

3 to 6 Months

More months if any of the following apply:

Job not secure
Difficult to find new job
Own a home

Health issue
Single-income household with dependents

Next, you identify the number of months you want to plan for.

[TEXT APPEARS]

The traditional rule of thumb is 3 to 6 months. Some experts say up to 12 months. What should you use? That will depend on your situation and risk tolerance.

Three months is a good minimum.

[TEXT APPEARS]

Increase the number of months if any of the following apply.

Your job is not secure
It would be difficult for you to find a new job due to lack of demand, constraints on where you can live, and so forth. If you know how long it could take to find a new job, this would be a good number to use.
Home owners will have a greater need due to potential home repair and appliance replacement
If you have chronic health issues
If you have dependents and are a single-income household

The more of these factors that apply, the more months you would want to consider using.

The best target for an emergency fund is what will allow you to sleep at night.

17 of 28

How Much of an Emergency Fund Do You Need?

M

Emer-gency Fund Size

Monthly Base Amount

Number of Months

$3,100/month

5 months

$15,500

18 of 28

How Much of an Emergency Fund Do You Need?

Emer-gency Fund Size

Number of Months

Monthly Living Expenses

(Option 1)

3 months

Default Emergency Fund

Monthly Base Amount

19 of 28

What Is Your Basic Emergency Fund Plan?

Map out a basic emergency fund plan.

4

20 of 28

What Is Your Basic Emergency Fund Plan?

Susceptible to Inflation

Tiering Strategy

Not in Risky Investments

Tier 3

Tier 2

Tier 1

Tier 0

Let’s discuss how to structure an emergency fund. An emergency fund needs to be available when the unexpected happens.

[IMAGE/TEXT APPEAR]

That means you usually don’t invest it in risky investments,

[IMAGE/TEXT APPEAR]

However, the low expected returns associated with low-risk investments makes them susceptible to inflation risk. Thus, in general, funds that are more accessible usually have lower rates of return and are exposed to inflation risk.

[IMAGE/TEXT APPEAR]

Often, a tiering strategy is used to try to soften the impact of inflation. With tiering, assets that have less of a chance of being needed are invested in higher-yielding investments that take more risk. For example, a certificate of deposit usually has a higher interest rate than a savings account because it often has an interest penalty for early withdrawal.

21 of 28

What Is Your Basic Emergency Fund Plan?

Identify the amount you will save in each tier.

	Current Amount	Target Amount	Surplus/ (Shortfall)	Account
Tier 0: Cash at Home (in a safe)	$300	$500
Tier 1: Savings, High-yield Savings, etc.	$1,000	$5,700
Tier 2: CDs, Treasury Bills, etc.	$0	$9,300
TOTAL TIERS 0-2:	$1,300	$15,500
Tier 3: Other Sources of Liquidity

Your basic emergency fund plan begins with identifying the amount you will allocate to each tier.

Let’s discuss the tiers as we allocate the $15,500 basic emergency fund.

[HIGHLIGHT]

Tier Zero consists of money you need to have immediate access due to a natural catastrophe, such as a tornado or hurricane. It is usually stored in a safe or other secured place in your home. It does not include money in your wallet. Think about how much you would need if you could not access an ATM for a few weeks.

[REMOVE HIGHLIGHT]

[HIGHLIGHT]

For our example, we’ll say $500.

[REMOVE HIGHLIGHT]

[HIGHLIGHT]

Tier 1 is money in a dedicated savings account that you can access immediately through an ATM, a bank teller, or electronic funds transfer request without any fees or penalty. A high-yield savings account is usually preferred since its interest rates are higher than a regular savings account. However, make sure any fees and minimum balances will work for you, and that you can access the money quickly through an ATM, debit card, or electronic funds transfer.

[REMOVE HIGHLIGHT]

[HIGHLIGHT] Think about the amount you might need in the most likely emergency need. For example, this could be a dollar amount, like $5,000 for a house repair. Or, if your job is not stable, a number of months of income. We’ll say two months, which is $6,200, less the $500 in cash at home, equals $5,700. Alternatively, you could ignore the $500 cash at home.

[HIGHLIGHT] Tier 2 assets are invested in CDs, Treasury bills, and so on, that typically earn a higher interest rate. Tier 2 amounts should be typically for situations for which you had time to avoid fees or early withdrawal interest penalties. For example, if your emergency fund was six months of income, you could have months four through six in 3-month CDs laddered so one matures every month.

[REMOVE HIGHLIGHT]

[HIGHLIGHT]

For our example, we’ll say 3 months or $9,300.

[HIGHLIGHT]

The Target Amount for total tiers zero to two is $15,500.

22 of 28

What Is Your Basic Emergency Fund Plan?

Identify the amount you will save in each tier.

	Current Amount	Target Amount	Surplus/ (Shortfall)	Account
Tier 0: Cash at Home (in a safe)	$300	$500	($200)	Safe
Tier 1: Savings, High-yield Savings, etc.	$1,000	$5,700	($4,700)	eBank HY
Tier 2: CDs, Treasury Bills, etc.	$0	$9,300	($9,300)	eBank HY
TOTAL TIERS 0-2:	$1,300	$15,500	($14,200)
Tier 3: Other Sources of Liquidity

23 of 28

What Is Your Basic Emergency Fund Plan?

Identify the amount you can save to address a shortfall.

Identify the amount you will save in each tier.

24 of 28

What Is Your Basic Emergency Fund Plan?

Set up automatic savings to address a shortfall.

Direct Deposit from your paycheck.
Monthly automatic transfer

Identify the amount you can save to address a shortfall.

Identify the amount you will save in each tier.

25 of 28

What Is Your Basic Emergency Fund Plan?

Set up automatic savings to address a shortfall.

Identify the amount you can save to address a shortfall.

Identify the amount you will save in each tier.

Monitor your plan.

While building it: Check your progress at least quarterly.

After it’s built: Review each year.

26 of 28

How Can You Address Common Obstacles?

Address common challenges to creating an emergency fund.

5

27 of 28

How Can You Address Common Obstacles?

Decrease expenses.
Increase income.
Both

Break it into smaller goals: $500, $1,000, one month, etc.
Focus on creating a habit of saving.

“The Shortfall feels overwhelming.”

“I have nothing to save.”

One mental obstacle is that the shortfall seems overwhelming.

[TEXT APPEARS]

If it does, break the goal into smaller parts. First $500 then $1,000. Next, one month of expenses, then two months of expenses, and so on.

Also, control what you can and make saving money a habit. You can always increase your monthly savings, for example, by the amount of a raise or repayment of debt you eventually pay off.

[TEXT APPEARS]

A second common obstacle is thinking you have nothing to save. How valuable is an emergency fund to you? Compare that value to each discretionary expense. Can you reduce discretionary spending to obtain that value? Are there service subscriptions you don’t use? Entertainment or luxury expenses you could do without? Could you shop smarter with coupons or comparison shopping? Alternatively, you could increase income by working overtime or getting a second job. Or possibly a combination of the two.

28 of 28

Taking Action!

1. Create your basic emergency fund plan

Default = 3 months of living expenses (shortcut)

2. Decide on amount to save.

3. Automate savings.

Now you know the what, the why, and the how of emergency funds. If you haven’t already, it’s time to act so you are prepared for financial emergencies.

[TEXT APPEARS]

Use the handout provided and walk through the steps we just reviewed to create your basic emergency fund plan. There are a few additional questions we did not review here that will help you with the process.

[TEXT APPEARS]

Remember, the most important thing here is to get started. If you don’t want to do a lot of calculations, target a fund of 3 months of living expenses. Calculate the living expenses using the shortcut method—which should take you a few minutes.

[TEXT APPEARS]

Then, decide on amount to save—regardless of the amount. Just start saving what you can in a dedicated savings account.

[TEXT APPEARS]

Finally, set up an automatic savings strategy. Adjust the amount as needed.

Then, you will be on your way to laying down a strong foundation to build your financial future on.