AFC Savings Strategies and Emergency Fund Planning 4 — Questions and Answers
Question 1: A self-employed freelancer with irregular income wants to build an emergency fund. Which approach is most appropriate for determining the target amount?
- Use the standard 3-month expenses guideline like a salaried employee
- Target 6-12 months of expenses due to income volatility (Correct answer)
- Keep only 1 month of expenses since freelancers can find work quickly
- Set aside a fixed dollar amount regardless of monthly expenses
Correct answer: Target 6-12 months of expenses due to income volatility
Self-employed individuals with variable income should target 6-12 months of expenses to account for income gaps between contracts or clients.
Question 2: Which savings vehicle offers both liquidity and FDIC insurance, making it appropriate for an emergency fund?
- Treasury bonds
- High-yield savings account at an FDIC-insured bank (Correct answer)
- Money market mutual fund
- Certificate of deposit with a 2-year term
Correct answer: High-yield savings account at an FDIC-insured bank
A high-yield savings account at an FDIC-insured bank provides immediate access to funds and federal deposit insurance up to $250,000.
Question 3: A couple has a combined monthly income of $7,000 and monthly expenses of $4,500. Their employer offers a 401(k) match up to 4% of salary. What should they prioritize first?
- Max out Roth IRA contributions before anything else
- Build a full 6-month emergency fund before investing
- Contribute enough to the 401(k) to capture the full employer match, then build emergency savings (Correct answer)
- Pay off all debt before saving or investing
Correct answer: Contribute enough to the 401(k) to capture the full employer match, then build emergency savings
Capturing the full employer 401(k) match is an immediate 100% return, making it the top priority before other savings goals.
Question 4: What is the primary disadvantage of keeping an emergency fund in a traditional checking account?
- It is not FDIC insured
- It typically earns little to no interest, reducing its real value over time (Correct answer)
- It cannot be accessed quickly in an emergency
- It is subject to capital gains taxes
Correct answer: It typically earns little to no interest, reducing its real value over time
Checking accounts typically pay near-zero interest, so inflation gradually erodes the purchasing power of emergency funds kept there.
Question 5: A client asks whether to use windfalls (tax refunds, bonuses) to build an emergency fund or pay down credit card debt at 22% APR. What is the AFC's best guidance?
- Always split windfalls 50/50 between debt and savings
- Pay off the high-interest credit card debt first, since the 22% cost exceeds any savings yield
- Build the full emergency fund first to avoid future borrowing (Correct answer)
- Invest the windfall in the stock market for higher returns
Correct answer: Build the full emergency fund first to avoid future borrowing
While high-interest debt is costly, having no emergency fund risks new high-interest debt when emergencies arise, so building a starter fund first (then aggressively paying debt) is often recommended.
Question 6: The 'pay yourself first' savings strategy refers to which practice?
- Negotiating a higher salary before accepting employment
- Automatically transferring a set amount to savings before spending on discretionary items (Correct answer)
- Paying off personal debts before contributing to household expenses
- Prioritizing retirement savings over all other financial obligations
Correct answer: Automatically transferring a set amount to savings before spending on discretionary items
Paying yourself first means automating savings transfers at the beginning of each pay period so savings occur before discretionary spending.
Question 7: Which of the following best describes a 'sinking fund' in personal financial planning?
- An emergency fund used only for catastrophic events
- A dedicated savings account for a specific anticipated future expense (Correct answer)
- A retirement account that gradually declines in value
- A savings account linked to a mortgage escrow
Correct answer: A dedicated savings account for a specific anticipated future expense
A sinking fund is money set aside regularly for a known future expense (e.g., car replacement, home repair), distinct from an emergency fund for unexpected costs.
AFC Savings Strategies and Emergency Fund Planning 4
A self-employed freelancer with irregular income wants to build an emergency fund.
Which approach is most appropriate for determining the target amount?