How Much Emergency Fund Should You Have And How To Get There
If you watched the nightly news during the latest government shutdown you would have seen stories about how people struggle when they aren’t getting a paycheck. Most Americans are not immune to having a set back at a job and it is a scary feeling to not know when the next paycheck will come. The emergency fund is what will help you bridge the
How Much Emergency Fund Should You Have And How To Get There
If you watched the nightly news during the latest government shutdown you would have seen stories about how people struggle when they aren’t getting a paycheck. Most Americans are not immune to having a set back at a job and it is a scary feeling to not know when the next paycheck will come. The emergency fund is what will help you bridge the gap in these hard times. This article should help determine how much emergency fund you should have and strategies on how you can get there.
We make a point of this in every financial plan we put together because of its importance. A lot of people will say their job is secure so they don’t need to worry about having an emergency fund. This may be true, nevertheless the emergency fund is not only for the most extreme circumstances but any unexpected expense. Anyone can have an unforeseen cost of $1,000 to $5,000 and most people would have to pay for this expense on a credit card that will accrue interest and take time to payoff.
Another common thought is, “I have disability insurance, so I don’t need an emergency fund”. Most disability insurance will not start until a 90-day elimination period has been met. This means you will be out of a check for that period but still have all the expenses you normally would.
Current Savings In The United States
“Smartasset” came out with a study in November 2018 that stated; of those Americans with savings accounts, the average savings account balance was $33,766.49. This seems like an amount that would be enough for most people to have in a “rainy day fund”. But that is the average. Super Savers with very large balances will skew this calculation so we use the median which more accurately reflects the state of most Americans. The median balance is only approximately $5,200 per “Smartasset”.
With a median balance of only $5,200, it doesn’t take much misfortune for that to be spent down to $0. At $5,200, it is safe to assume that most Americans are living paycheck to paycheck.
If your income only meets your normal expenses, you need to ask yourself the question “where am I coming up with the money for an unexpected cost?”. For a lot of people, it is a credit card, another type of loan, or dipping into their retirement assets. By taking care of the immediate need, you shift the burden to another part of your financial wellbeing.
Emergency Fund Calculator
There is no exact dollar amount but a consensus in the planning industry is between 4-6 months of living expenses. This is usually enough to cover expenses while you are searching for the next paycheck or to have other assistance kick in.
It is important for everyone to put together a budget. How do you know what 4-6 months of living expenses is if you don’t know what you spend? Putting together a budget takes time but you need to know where your money is going in order to make the adjustments necessary to save. If you are in a position that you don’t see your savings account increasing, or at least remaining the same, you are likely just meeting expenses with your current income.
Resource: EXPENSE PLANNER to help you focus on your spending.
I Know My Number, How Do I get There?
Determining the amount is the easy part, now it is getting there. The less likely option would be going to your boss asking, “I need to replenish my emergency fund, can you increase my pay?”. Winning the lottery would also be nice but not something you can count on.Changing spending habits is an extremely difficult thing to do. Especially if you don’t know what you’re spending money on. Once you have an accurate budget, you should take a hard look at it and make cuts to some of the discretionary items on the list. It will likely take a combination of savings strategies that will get you to an appropriate emergency fund level. Below is a list of some ideas;
Skip a vacation one year
Put any potential tax refund in savings
Put a bonus check into savings
Increase the amount of your paycheck that goes to savings when you get a raise
Side work
Don’t upgrade a phone every time your due
Downgrade a vehicle or use the vehicle longer once paid off
Reward Yourself
There is no doubt some pain will be felt if you are trying to save more and it also takes time. Set a goal and stick to it but work in some rewards to yourself. If you are making good progress after say 3 months, splurge on something to keep your sanity but won’t impact the main objective.
Where To Keep Your Emergency Fund?
This account is meant to be liquid and accessible. So locking it up in some sort of long term investment that may have penalties for early withdrawal would not be ideal. We typically suggest using an institution you are familiar with and putting it in a savings account that can earn some interest.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.
Target Date Funds: A Public Service Announcement
Before getting into the main objective of this article, let me briefly explain a Target Date Fund. Investopedia defines a target date fund as “a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal”. The specified period of time is typically the period until the date you “target” for retirement
Target Date Funds: A Public Service Announcement
Before getting into the main objective of this article, let me briefly explain a Target Date Fund. Investopedia defines a target date fund as “a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal”. The specified period of time is typically the period until the date you “target” for retirement or to start withdrawing assets. For this article, I will refer to the target date as the “retirement date” because that is how Target Date Funds are typically used.
Target Date Funds are continuing to grow in popularity as Defined Contribution Plans (i.e. 401(k)’s) become the primary savings vehicle for retirement. Per the Investment Company Institute, as of March 31, 2018, there was $1.1 trillion invested in Target Date Mutual Funds. Defined Contribution Plans made up 67 percent of that total.
Target Date Funds are often coined as the “set it and forget it” of investments for participants in retirement plans. Target Date Funds that are farther from the retirement date will be invested more aggressively than target date funds closer to the retirement date. Below is a chart showing the “Glide Path” of the Vanguard Target Date Funds. The horizontal access shows how far someone is from retirement and the vertical access shows the percentage of stocks in the investment. In general, more stock means more aggressive. The “40” in the bottom left indicates someone that is 40 years from their retirement date. A common investment strategy in retirement accounts is to be more aggressive when you’re younger and become more conservative as you approach your retirement age. Following this strategy, someone with 40 years until retirement is more aggressive which is why at this point the Glide Path shows an allocation of approximately 90% stocks and 10% fixed income. When the fund is at “0”, this is the retirement date and the fund is more conservative with an allocation of approximately 50% stocks and 50% fixed income. Using a Target Date Fund, a person can become more conservative over time without manually making any changes.
Note: Not every fund family (i.e. Vanguard, American Funds, T. Rowe Price, etc.) has the same strategy on how they manage the investments inside the Target Date Funds, but each of them follows a Glide Path like the one shown below.
The Public Service Announcement
The public service announcement is to remind investors they should take both time horizon and risk tolerance into consideration when creating a portfolio for themselves. The Target Date Fund solution focuses on time horizon but how does it factor in risk tolerance?Target Date Funds combine time horizon and risk tolerance as if they are the same for each investor with the same amount of time before retirement. In other words, each person 30 years from retirement that is using the Target Date strategy as it was intended will have the same stock to bond allocation.This is one of the ways the Target Date Fund solution can fall short as it is likely not possible to truly know somebody’s risk tolerance without knowing them. In my experience, not every investor 30 years from retirement is comfortable with their biggest retirement asset being allocated to 90% stock. For various reasons, some people are more conservative, and the Target Date Fund solution may not be appropriate for their risk tolerance.The “set it and forget it” phrase is often used because Target Date Funds automatically become more conservative for investors as they approach their Target Date. This is a strategy that does work and is appropriate for a lot of investors which is why the strategy is continuing to increase in popularity. The takeaway from this article is to think about your risk tolerance and to be educated on the way Target Date Funds work as it is important to make sure both are in line with each other.For a more information on Target Date Funds please visit https://www.greenbushfinancial.com/target-date-funds-and-their-role-in-the-401k-space/
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.
Target Date Mutual Funds and Their Role in the 401(k) Space
A target date mutual fund is a fund in the hybrid category that automatically resets the asset mix of stocks, bonds and cash equivalents in its portfolio according to a selected time frame that is appropriate for a particular investor. In simpler terms, an investor can purchase a target date fund based on their anticipated retirement date and the fund will
target date mutual funds
In recent years, a growing trend in the 401(k) space has been the use of target date mutual funds.
Target Date Mutual Funds
A target date mutual fund is a fund in the hybrid category that automatically resets the asset mix of stocks, bonds and cash equivalents in its portfolio according to a selected time frame that is appropriate for a particular investor. In simpler terms, an investor can purchase a target date fund based on their anticipated retirement date and the fund will automatically become more conservative as the investor approaches retirement.
This is often times a suitable investment for the average investor or participant in a 401(k) plan that would not typically make allocation adjustments on their own. During the financial crisis of 2008 and 2009, many investors approaching retirement were overexposed to the stock market and lost half of their savings with no time to make it back before retirement. This is where the benefit of a well-managed target date fund would have been useful as investors who needed an allocation change as they approached retirement would have got it. Emphasis on the well-managed.
At year end 2013, there was approximately $595.5 billion dollars invested in target date mutual funds, up from approximately $111.9 billion in 2006 based on a study conducted by Morningstar. With so much money being placed in these funds, it is important to know how they work and what to look for when choosing the correct fund for your risk tolerance and time horizon.
As mentioned previously, the allocation of assets within a target date fund will automatically rebalance throughout the life of the investment to focus more on income. With that being said, how does the rebalancing happen and how often does the rebalancing take place? The rebalancing takes place automatically when fund managers of that target date fund determine the allocation in the fund no longer meets its intentions. It is argued that most target date mutual funds do not rebalance nearly enough as some can be as long as 4-5 years.
It is important to know that the date of a target date fund is the date the investor plans to retire and is not the date in which the fund is at its most conservative allocation. Fund families operate their target date mutual funds very differently. For example, one fund family may have a 2020 fund that is 30% stocks and 70% bonds compared to another more aggressive fund family that is allocated 60% stocks and 40% bonds in their 2020 target date fund.
There are arguments for both allocations. Since an investor is at their retirement age, they should typically be more conservative. On the other hand, just because the investor hit their retirement age they may not be taking distributions from the account for another 5-10 years, and therefore could possibly achieve more growth.
A target date fund can be a suitable investment option for investors who would like a hands off approach in their 401(k), but participants must be aware that there is still due diligence necessary throughout the life of the investment. Below is a chart showing the results of a study conducted by Morningstar in 2010. It shows the allocation of target date mutual funds for different fund families during the financial crisis of 2008 and 2009. These target date mutual funds were meant for investors retiring in 2010 and therefore should have been allocated in a way that would not over expose them to a significant decline in the market two years from retirement.
comparing target date fund performance
As you can see, the equity (stock) allocation varies greatly between fund families and the over exposure led to significant declines in investors accounts. Too many people had their retirement account nearly halved two years from retirement which is devastating for an individuals quality of life.
There are definitely pitfalls to target date mutual funds but they can be appropriate in the right circumstances. It is important that investors are educated on what target date mutual funds are and more importantly what they are not. Here are a few takeaways that may help you determine which, if any, target date fund is appropriate for you.
Determine Your Risk Tolerance First
The first questions an investment advisor will typically have for a client are: “What is your time horizon?” and “What is your risk tolerance?”. Since target date mutual funds allocate assets for a group of investors based on a date in the future, the only piece that is somewhat satisfied is time horizon. Just because a group of investors have the same time horizon does not mean they should be invested the same way. Fund managers cannot allocate funds in a way that satisfies both questions without knowing the risk tolerance for each individual investor. That means, the risk tolerance piece relies on you. Two 45 year old investors may be 20 years from retirement and have completely different portfolio allocations due to their risk tolerance. One may be more aggressive and tolerant of stock market fluctuations while the other may be conservative and less willing to risk their savings. Even though each investor has the same time horizon, the appropriate portfolio for each would vary greatly. It is important to know your risk tolerance and apply that knowledge to the appropriate target date fund.
Research the Different Target Date Fund Options
As shown in the chart on the previous page, the asset allocation for a target date fund for one fund family could be drastically different when compared to the same target date fund for another fund family. This can be confusing for investors which is why it is important to research the fund and the current allocation before investing. The charts below show the asset allocation of two 2020 target date mutual funds from different families.
401K target date funds
Both target date mutual funds are the same in terms of retirement date but drastically different in exposure to the stock market. The MFS 2020 fund with approximately 63% allocated to bonds/cash and 37% to stocks is a much more conservative portfolio than the Fidelity 2020, which is approximately 37% bonds/cash and 63% stocks. An investor with 5 years to retirement could have very different objectives with their retirement account and therefore each fund may be appropriate as a 2020 fund. An over exposure to the stock market for someone retiring in 5 years could be devastating as shown in 2008/2009 which is why it is important for each individual to determine their time horizon, risk tolerance, and investment objectives when selecting the correct target date fund for their portfolio.
Difference Between Target Date and Active Management
Although target date mutual funds are often referred to as “set it and forget it”, there are a number of factors that must be taken into consideration. Most target date mutual funds are typically managed exclusively on time horizon. Fund managers traditionally do not make significant allocation adjustments to these types of funds based on changing market conditions which can leave investors exposed to big drops in the stock market as they approach retirement. Investors within 10 years to retirement should work closely with their investment advisor to make sure they have the right mix of stocks and bonds in their portfolio.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally , professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, pleas feel free to join in on the discussion or contact me directly.
