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Stuff Happens. Is Your Emergency Fund Ready?

Jun 20, 2021 5 min read

Key takeaways

  • Rainy-day savings of three to six months’ worth of living expenses—or more—should be a top financial priority.
  • Emergency funds have to be there when you need them—even at the cost of earning potential.
  • CDs or conservative investment accounts can make sense for some of your emergency stash.

 

Emergencies, accidents and unforeseen events happen when we least expect them. From unexpected health expenses to sudden but necessary car and home repairs—not to mention possible job loss (can you say COVID-19?)—an emergency fund serves as a safety net for rough times and can help to ease the financial burden that comes along with them.

 

 

What is an emergency fund?

An emergency fund is exactly what it sounds like: money in an emergency savings account you set aside for a “rainy day,” i.e., to cover unexpected expenses—usually big ones, like facing a sudden layoff or loss of employment.

Along with paying off revolving debt like credit card balances, building an emergency fund should be at the top of your priority list of financial goals, ahead of saving for a down payment on a home, funding your kid’s future college, or even investing for your own retirement.

 

Where should I keep my emergency fund?

Conventional wisdom on where you should keep your emergency fund says to use a place that’s super safe 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).

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.

 

Why start an emergency fund?

Life is full of unexpected events, and it’s impossible to know when they’ll hit (just that they will, eventually). You never know when your car is going to break down, or a roof will spring a leak.

Having the cash on hand to deal quickly with such events can prevent the financial burden from compounding. If you have enough money to pay for car repairs or cover a rental car while yours is in the shop, for example, you don’t have to also worry about missing work because you can’t get there. If you have the cash to pay your utilities while you’re out of work recovering from surgery, you don’t have to worry about having your water shut off. Even one missed mortgage payment can lead to a lower credit score, which can make it harder or more expensive to borrow money in the future.

An emergency fund allows you to plan for any of those events, even if you don’t know when they’re going to happen

On the other hand, without an emergency fund in place, those in crisis might have to make money moves that have long-term consequences. Withdrawing money from your retirement account, for example, or using high-interest credit cards can throw your entire financial plan off course. Having an emergency fund gives you money to cover your ongoing bills in the short-term without having to take on additional debt. That way, once the emergency has passed, you can focus on rebuilding your emergency fund, rather than dealing with new creditors.

 

How much should you have in an emergency fund?

Experts recommend saving at least three to six months’ worth of living expenses to build a sufficient emergency fund. To calculate how much you might need for a rainy day, 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.

 

What you can do next

Take advantage of bank programs that automatically stash a few cents off debit card transactions—or, better, sweep a monthly amount—into your savings account. And think outside the house: You might be able to raise cash by selling clothes you no longer need, along with books, furniture, kitchenware and electronics. Earmark that extra money—plus earnings from side gigs, surveys, whatever—for emergencies.

Also examine your benefits plan to see if you’re taking full advantage of what your employer already offers. For more help saving money, look into discount programs, partnerships and affinity offers.

For Compliance Use Only:1039300-00002-00

 

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