Save Your Clients From Americans’ Biggest Mistake

The biggest financial mistake most Americans are making is not maintaining an emergency fund.

“I’ve written and spoken about this issue before, but it bears repeating because this truly is a national crisis,” said Carla Dearing, chief executive officer of SUM180, an online financial wellness service located in Lexington, Ky. “The single worst money mistake you can make is to fail to maintain a cash cushion for emergencies.”

Nearly half (49 percent) of Americans are still living paycheck-to-paycheck, even as the “Great Recession” ended in 2009, according to a GoBankingRates survey.

Nineteen percent of Americans have nothing set aside to cover an unexpected emergency, according to HomeServe USA data. Nearly 31 percent of Americans don’t have at least an extra $500 set aside.

“The lack of a financial safety net is an incredibly precarious and stressful situation to be in,” Dearing said. “Eventually, an event like a job layoff or a medical emergency will happen to most of us. Without an emergency fund, this can trigger debt that gradually spirals out of control.”

So why do few Americans set up an emergency fund?

“Many people I've found don't treat emergencies with urgency and respect,” said John Savin, founder of Savin Wealth Management in Boca Raton, Fla.

The gambling mentality of “I'll take shot that it won't happen” is a bad attitude and poor planning for the uncertainties in life, he added.

“The problem is not defining emergency in depth,” Savin said. “If income is lost how do you pay the necessary bills to not get kicked out of your home, power turned off or put food on the table. But how about unexpected health- or home-related expenses?”

Many people are forced to run up credit card debt, he said.

For advisors looking for guidance on how to successfully engage clients on emergency funds, Savin advises focusing on two methods:

• Ask your client how much cash in the bank would help them sleep okay at night?
• Add all your client’s monthly expenses and include an additional 20-50 percent depending on their age and sources of income. “I would lean on the higher side and save up 6-to-12 months of this amount to play it extra safe,” he added.

'Rainy Day Fund'

The primary roadblocks to building emergency funds is client disinterest, said Jack Shinn, founder of J Shinn & Associates, in Glen Rock, N.J.

“Most people that I meet with that do not have an emergency fund have never used an adviser and have not included it in their planning,” Shinn said. “We all know we have to have life insurance to some degree, we have to pay our bills, but many people are not well-schooled in the three major parts of a good financial plan, which includes the idea of creating and maintaining a 'rainy day fund.'”

When presenting the idea to new clients, Shinn always tells them they have to pay themselves first.

“After taking a long hard look at the income, expenses, and assets and liabilities, I provide a plan that includes putting aside a modest amount of money to, as I say to them, fix the car or be able to plug the leak in the ceiling,” he said. “When presented this way, most folks seem to get it and begin paying themselves first because they see the value in doing it.”

Structurally, advisors need to lay out a specific road map for clients who may be reluctant to plow ahead with an emergency fund.

“Financial planning doctrine tells us to have three-to-six months of expenses on hand in a readily accessible, ideally interest-bearing account,” said Jacob Milder, a money manager at Oak Street Investment Advisors in Greenwood Village, Colo. “For wealthier clients, it's important to consider a number of factors when determining how much coverage they need, including a breakdown of expenditures, risk of an emergency occurring and duration of the emergency."

To identify whether the emergency fund is enough, advisors need to start by looking at the percentage of expenditures that are discretionary, like dining out and entertainment versus fixed expenses like a mortgage and car payment, Milder said.

“Once we back out a large percentage of discretionary expenditures and savings, we have a good idea of what our monthly expenses we need to cover,” he said. “We find some people surprised at what they really need when we look at a worst-case-scenario budget.”

Identify the Risks

It's also important to identify the risks of an emergency occurring.

“If the emergency we're trying to fund is job loss, we need to look at the likelihood of that happening,” Milder said. “Physicians, or tenured professors, for example, are typically not at a very high-risk for unexpected job loss and may not need as much money sitting around earning low interest.”

Someone just starting out or in a highly cyclical industry may be more susceptible
and thus want to work hard at saving four-to- six months’ worth of fixed expenses, Milder said.

“Typically however, if they're just starting out, their fixed expenses should be lower, and finding a job replacement may be quicker than that of a professor or physician,” he added.

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms, including CBS News, The Street.com, and Bloomberg. Brian may be contacted at [email protected].

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