Unexpected financial burdens can come in many forms, from car damage to a serious illness, yet many clients aren’t prepared for such expenses. Moreover, they seem disturbingly nonchalant about it.
Coming up with an emergency savings fund is a crucial part of financial planning, but advisors say getting clients to contribute the right amount is daunting.
“The biggest challenges are not that clients don't understand the need for a savings fund, but that the savings fund they have in mind is too small,” says advisor Roy Janse of DeHollander and Janse Financial Group. “With interest rates so low, the mentality is often, ‘I'll borrow it, if I need a more significant sum.’ This can be problematic.”
Some experts recommend that a household have six months’ worth of emergency funds set aside in order to protect against sudden financial burdens. However, only 29% of adults say that they have a reserve of this size, according to a 2018 survey from Bankrate. Yet 62% say they are comfortable with their level of emergency savings. To give more context, a 2017 survey from GOBankingRates, a personal finance resource, found that 57% of respondents said they had less than $1,000 in a savings account.
“The three to six-month period is intended to coincide with the waiting period of disability income insurance,” says advisor Christopher White of Peoples Bank. Also playing a part in that rule-of-thumb are job security, income level consistency and whether there is more than one income earner involved, he notes.
In order to get clients to build up a reserve, Janse tries to put a more positive spin on what the funds can be used for by getting to the heart of what he calls clients’ “sleep well at night factor.”
“What we really try to do is walk [clients] through what I always describe as the known unknowns,” Janse says. “We don’t know what’s going to happen, but realistically getting them to understand that something will happen whether it’s the car, the AC unit or the roof.”
Janse also reminds clients that this isn’t just for expenses that pop up when something bad happens. Sometimes, a golden opportunity arises unexpectedly.
One of his high-net-worth clients had been looking to buy some property near Lake Keowee in Greenville, South Carolina — where his firm is based. Janse explained that the property in that area tends to go quickly and it was by chance that the client learned of an availability.
“A friend of a friend had noticed [the client] could jump on it right away,” he says. “And we could walk up within 24 hours and say ‘look we can pay cash.’”
CASH IS KING, BUT GETS A LOW RETURN
Another concern with establishing a reserve fund can be the low rate of return on cash. And even though an emergency fund can often be in interest-bearing or dividend-yielding accounts, there are some exceptions, says advisor Dave Root, founder of the Dynasty-affiliated RIA DB Root.
“For our clients who are nearing retirement, or at retirement, we tend to keep large liquid — essentially cash balances — in their account so that as they are withdrawing income from their portfolios we can take it from cash as opposed to having to sell something,” Root says.
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“We’re collecting dividends and interest and that’s replenishing our cash to some degree and we have it planned out so there is plenty of liquidity to draw from.”
This can present its own challenges, however, because high-net-worth investors often view this issue differently. There is a perception that scrambling to find the funds for a broken water heater or broken leg isn't a concern. Consequently, they can be reluctant to establish a large reserve, says Root.
One more concern among retired clients is health care, Root says. Most of his clients, he says, have that risk well covered but there is always the possibility of a bad diagnosis that all of a sudden requires a greater chunk of the finances.
“It becomes a fairly quick juggling act to determine how that will be paid for if you don’t have insurance like long-term care insurance,” Root says. “So having a healthy savings account makes that so much easier.”
