Why do I need an emergency fund?
Once you’ve mastered the art of consistently spending less than you make, what should you do with the savings?
- Invest it in stocks?
- Set up a CD ladder?
- Buy a boat?
- Put it into a savings account
Give yourself a pat on the back if you answered anything but 3 (if you did answer 3, here’s a link to a debt councilor).
Depending on your risk tolerance and specific needs, your emergency fund can take a couple different forms. By definition, an emergency is a situation where you need cash quickly. It could be anything from a flat tire to the zombie apocalypse. The idea is to have quick access to cash so you don’t need to take on debt (especially high-interest credit card debt) to get through the emergency.
Case in point: on January 29, 2016 at about 1:30 am, someone destroyed my car. Sniff. Don’t judge me. Yes, I know a Scion xB is not a car to get teary-eyed over. Because we have cash on hand, we didn’t panic. We rented a car while the claim was being processed. And, we had enough cash to make a significant down payment on our replacement vehicle even before the claim was paid out. This brings us to point 2:
How much should I keep in my emergency fund?
Most folks will suggest 3-6 months of expenses, depending on your risk tolerance. I tend to lean more towards 6 months, and I consider it a joint emergency/opportunity fund (more on that in another post).
Where should I keep it?
Again, I think there is some wiggle room here depending on your specific situation. I would absolutely keep at least 3 months of expenses in a savings account. It’s secure, ready to use at a moments’ notice, and may even earn a smidgen of interest to ward off inflation. Depending on your personal risk factors, you may want more cash readily available. Once you have months 1-3 set aside in savings, what next?
For months 3-6 and beyond, i think you have some more options. Savings is the easy answer. But that may feel like you’re losing money realtor to inflation. A Certificate of Deposit (CD) ladder may be an option where you trade some liquidity for a bit more interest. I would also consider a low risk bond ladder or fund as another way to keep emergency/opportunity funds (likely a subject for a future post).
Regardless of how you store your emergency fund, it is critical to have one to avoid taking on debt when you have a different, unanticipated expense. How much do you keep in your emergency fund? What type of vehicle do you use?
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