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If you’re interested in making the most of your legacy giving, there are many strategies to keep in mind, but the impact of these strategies can be diminished dramatically, if not completely, by not having one of the most foundational elements of financial planning – an emergency fund.

Why an Emergency Fund is Important

Those with legacy goals, and especially charitable legacy planning goals, often think big picture. While there’s nothing wrong with dreaming big, you don’t want to become so focused on your long term legacy giving goals that you lose sight of the basic financial planning components, such as an emergency fund, that keep you financially healthy in the present. Building a legacy is a lot like building a physical building: if you want it to stand over generations and not crumble with the passing of time, it must be built on a strong foundation, and an emergency fund is a key aspect of that foundation.

I can attest to this personally. When I was younger, I was so focused on my charitable giving goals, that I didn’t make paying off debt or building up my cash savings a priority. The problem is that this almost always ends up hurting you more in the long run, and I don’t just mean by creating more stress and negatively impacting your cash flow (though it can do that, too). Failing to create an adequate emergency fund can also end up negatively impacting your legacy giving goals. In my experience, this latter concern is an area some legacy builders (especially younger ones) overlook or take for granted, so it’s what I’ll focus on in this post.

I cannot stress enough the importance of having an adequate emergency fund. One financial mishap or hardship can derail even the most grandiose legacy plans, and Murphy’s Law suggests there is no escaping it – inevitably, at some point, something will go wrong.

If you don’t currently have an emergency fund, there’s no time like the present to start saving. While there are ideal savings goals to eventually reach, which I’ll get to in a moment, if those goals feel too lofty right now, don’t let that stop you from saving what you can. A good place to start is with a modest goal of saving $1K in cash (preferably somewhere you can’t get to it easily if temptation strikes).

How Much Emergency Funds Should You Have While Still Working?

While anything is better than nothing, the ideal emergency fund when you’re still working will consist of a cash amount equal to 3-6 months of expenses. You’ll notice, this is a fairly wide range. When deciding where to land in this range you’ll want to consider the stability of your income as well as your financial obligations.

For example, if you’re a two-income household with no children and both income sources come from steady income in reliable industries, your cash needs will likely be on the lower end of this range. On the other hand, if you’re currently self-employed, a single-income household, and have three children to support, you’ll likely need an emergency fund on the higher end.

Regardless of the size of the emergency fund, its goal is to provide a cushion for spending shocks (like unexpected home or car repairs), but more importantly it serves as a cushion for income shocks. If you get laid off or otherwise lose an income stream, an emergency fund buys you time to get back on your feet and find a way to replace that income.

Without an emergency fund, you have no cushion for unexpected spending or income shocks. This will almost certainly create short term financial stress, but it may also have longer reaching consequences. For example, without an emergency fund, you may be forced to rely on credit cards, which almost always come with incredibly high interest rates. This can mean having to divert more of your money to getting out of debt instead of using your wealth to save for longer term goals. After all, every dollar you pay in interest and finance charges is one less dollar that can be used for legacy giving.

How Much Emergency Funds Should You Have in Retirement?

So, we have talked about an emergency fund if you’re still working, but what about if you’re in retirement or otherwise distributing regularly from your portfolio? In this case, you generally want to build up a cash position equal to at least 1-2 years of portfolio withdrawals, which effectively insulates you from extreme market volatility. Why 1-2 years?

Historically, the median time for a portfolio to recover from bear market losses has been around two years and three months. When you have a portfolio that is balanced with bonds, as most retirees do, that volatility is reduced because bonds help to counterbalance the volatility of equities, providing a buffer against the full furies of the stock market.

So, this 1-2-year cash cushion effectively insulates you from having to sell in the depths of a bear market. Without this cash cushion in your portfolio, you run the risk of exhausting your cash in the middle of a market downturn, when you could be forced to liquidate stocks while they are low.

By maintaining 1–2 years of cash, the idea is that you leave that cash alone during bull markets (when the market is going up) and just sell stocks and bonds to meet your cash needs. Then, when the bull market ends and a bear market begins, you stop selling and switch to spending down your cash. By the time you’ve depleted that 1–2-year cash cushion, your portfolio is likely to have recovered from the worst of the bear market, so you can sell stocks and bonds again (including to replenish the cash cushion).

As you can see, an emergency fund for those who are retired has implications for financial health, much as it does for those still working. The difference for those who are retired is that they are typically on a fixed income, and do not have the ability to make up any difference in future years. The impact to the legacy of that individual, whether that be to future generations, charitable, or a combination of both, is clear – the more wisely you can use your money in these years, the more you can leave to the people and causes dear to you.

How Should You Invest Emergency Fund Cash?

Finally, let’s talk about options for investing the cash in your emergency fund, whether you’re still working or retired. In a low interest rate environment, where cash is yielding next to nothing, it can be tempting to “reach for yield” by moving cash reserves into bonds or something else that pays higher interest. Keep in mind, though, that the purpose of this emergency fund is to be there when you need it unexpectedly.

Cash or money market funds are about as low-risk as you can get in the investment world (not completely free of risk, however, because you still have inflation risk), whereas bonds carry the risk of principal losses if interest rates go up (albeit much less volatile than stocks, and shorter term bonds are much less volatile than longer term bonds). So, the danger is that bonds go down in value right when you need to access that money.

Because of this added risk, I generally advocate keeping emergency funds in cash or money market funds. If you are accumulating cash above and beyond the emergency fund for a short-term spending goal like a house or car purchase, where you have more clarity on the time horizon, maybe you consider short term bonds or CDs (when you know you won’t need the money until that CD matures), but you generally want to keep the emergency fund as risk-free as possible.

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