How To Balance Retirement Savings Against Emergency Funds In A Volatile Economy

When you have a limited budget, it can be hard to decide whether to save for retirement or an emergency. This is especially true when the economy is unstable.

And the banking crisis has made people even more worried about a recession. The failure of Silicon Valley Bank and Signature Bank has made the stock market even more volatile. Looking at your retirement accounts can cause you to enter a state of depression.  

An emergency fund is a necessary component of any financial strategy. It can provide a buffer to help you stay afloat if you experience financial hardship or an unexpected expense. Having an emergency fund can give you peace of mind knowing that you are prepared for life’s surprises.

Even though the maximum amount you can put into a 401(k) has gone up to $22,500 in 2023, experts say you shouldn’t give up emergency funds to put in the maximum amount.

A new report by Fidelity Investments in 2023 found that more than half of their savers are prioritizing short-term financial goals, such as emergency funds. A recent poll by Personal Capital found that one of the main aims for 2023 is to create an emergency fund.

Certified financial planner Catherine Valega, proprietor of Green Bee Consulting in Boston, stated, “There is always a balance.” She stated that while maximizing your 401(k) should be a priority, emergency funds are equally essential.

Strive for the maximum 401(k) match.

Leslie Beck, CFP and owner of Compass Financial Management in Rutherford, New Jersey, provides a “rule of thumb” for deciding between retirement and emergency savings. She always suggests contributing enough to your 401(k) to receive the full employer match. She advised that if your emergency savings are insufficient after that point, you should “absolutely” redirect any additional funds toward building a cash reserve.

How much is required for an emergency fund?

If you’re single, Beck advocates accumulating about a year’s worth of basic expenses to cover housing, food, and utilities. Other advisors have recommended three months to one year of expenses, depending on your circumstances.

You should have a year’s worth of critical costs in the event of a downturn in the employment market, which we may or may not be approaching, she said, noting that it sometimes takes longer than anticipated for higher-paid employees to find a job following a layoff. Her advice changes for couples with two incomes. Beck said for couples; she would reduce it to six months, or maybe even three months, depending on their employment sector.

Beck added that there might be some flexibility if you have access to a home equity line of credit, which may be an additional source of cash for unexpected expenses. Yet, you must be “very careful” when tapping equity since borrowing following a job loss might put your house in jeopardy, according to her.

Valega recommends a 12- to an 18-month emergency fund, acknowledging that she’s more conservative than others. However, the precise amount depends on your industry and personal preferences. For instance, she may push IT clients to set aside more than healthcare clients.