What price for safety?
Conventional wisdom holds that you should keep your emergency fund in a place that’s supersafe and readily accessible, like a bank savings account (or even under your mattress).
That’s true, to a degree. But a newer school of thought asks, “With interest rates so low recently, why set aside a pot of dough you hope never to use in an account where it’ll earn next to nothing?” (Worse, because inflation eats away at your spending power, in real terms your money could earn less than nothing.) Besides, not every emergency (think unexpected medical costs or mortgage payments if you lose your job) will demand that you have your cash (or check) in hand that day (busted water heater in mid-January).
Strike a balance
The trick is to tread the line between reasonable liquidity (knowing your money will absolutely be there when you need it) and growth (aiming to earn enough to at least keep pace with inflation).
So, for a little extra oomph, you might consider casting at least some of your safety net in a certificate of deposit (CD) that matures in a few months to a year, or even in a conservative investment account—the kind that holds a fair share of “cash” and fixed-income investments (bonds), maybe along with some stocks. True, if you need to tap it, you might not have the money for a few days (or weeks or months for a CD without penalty). But realistically, how many emergencies will demand immediate access to cash?
If you go this route, it may be best to oversave—target a larger emergency fund than you might if you were to stick with a savings account (or inner springs) alone.
How much is enough?
Experts recommend saving (are you sitting down?) at least three to six months’ living expenses. So total up what your household spends in a typical month—everything from gas to groceries, mobile bill to mortgage payments. For emergency purposes, separate the must-haves (say, diapers) from the nice-to-haves (dinners out) from the, well, seriously? (day-glo lattes). Then take the former and multiple by three (to six or more).
Of course, building a five-figure (or bigger) emergency fund can be a tall order, so start small—and save steadily.