Life is fraught with uncertainties and the unexpected, which is why an emergency fund is a must for every individual or household. As part of a sound financial plan, your emergency fund functions as a personal safety net or buffer, there to catch and cushion you when life’s path gets a little rocky. With that said, there’s a lot more to know about an emergency fund than just saving up money. How much should you have, where should you keep it, and what should you do with it are all important questions to address in order to achieve a real understanding of your emergency fund and its role.
What is an Emergency Fund?
As the name suggests, an emergency fund is an amount of money set aside in case of true emergencies. For purposes of this discussion an emergency is an immediate, necessary, and unexpected expense; unexpected medical expenses, car or home repairs, and unanticipated unemployment are good examples. An emergency fund isn’t there to allow for spontaneous purchases, impulse buys, or recreation—the whole point is to have an amount of money set aside for life’s real mishaps.
How Much Money Should You Have?
This is a tougher question, as it varies from person to person and circumstance to circumstance. Most financial experts agree, however, that you should have at least 60 days worth of basic operating costs—the basic and necessary expenses to keep your household running—set aside in an emergency fund. Many financial advisors got a bit further and suggest that 90 days to six months is a better option, as that is more likely to cover a period of unexpected unemployment.
For most of us, this means that building up an emergency fund is a long term goal. If you save 10% of your monthly household income, you’ll need 10 months to build up one month’s worth of emergency fund. You’ll need 60 months—five whole years—to get to the six month level. That’s OK: as is so common in financial planning these things don’t happen overnight. However your emergency fund should be part of your regular monthly budget when possible, and you should keep after it until you achieve your goal.
Where to Keep Your Emergency Fund
Now that you’re in the process of acquiring an emergency fund, the next question is where to keep it. There are a number of options here, which appeal to different people based on circumstance and need.
A traditional savings or checking account is a quick and easy option for your emergency fund, leaving your money accessible and simple to manage. However, it comes with a couple of downsides. You won’t accrue the interest you could with some other modes of saving, and easy access to the money means that you might be tempted to use it for purposes other than an emergency. It’s something you’ll have to think about, frankly and honestly.
A high-yield savings account is a good overall option, as they generally offer higher interest rates and fewer restrictions than a traditional savings account. They are also federally insured up to $250,000, which can provide a bit more peace of mind should an emergency arise.
Certificates of Deposit (CD) may be an attractive option under the right circumstances. CDs offer a fixed rate of return over a set period of time, generally anywhere from one month to seven years with longer periods yielding greater returns. The down side to CDs is that your money may be more difficult to access and early withdrawal may cost you a penalty. If you choose CDs as the financial tool for your emergency fund, you might consider taking out multiple CDs with different time lines attached. This leapfrog approach minimizes the risks of having to pull money out of any one fund too early. It requires a bit more management on your part, but the payoffs might make it worth the while.
Some Final Thoughts About Emergency Funds
When a discussion of emergency funds comes up, it inevitably raises the question of how much, if any, should be in the form of cash. In this case, by cash we mean physical money that is in your immediate possession or control. As always, the answer varies depending on your circumstances.
An emergency cash reserve can be a lifesaver under some circumstances. Due to power outage, natural disaster, or other calamity banks and ATMs may not be available and credit card machines may not be working. A ready cash reserve may save the day, allowing you to make unexpected or even necessary purchases under extreme circumstances. If you live in an area prone to natural disasters—particularly disasters that may require evacuation—you may find that keeping part of your emergency fund in cash helps a great deal. You do however have to maintain some discipline in the use of your emergency cash—it’s there for emergencies and the unexpected, not for when you forgot to go to the ATM and want to order a pizza.
With all that said, we should reiterate that an emergency fund is a necessity as part of a serious and well thought out financial plan. If you’re serious about building up a long term emergency fund as well as other savings and investments, it may be worth your time to engage the services of a financial planner. Expert advice on navigating the various laws and regulations surrounding your money can help you avoid major pitfalls while finding even more profitable means toward your goals.
At OmniStar Financial, we’re here to help illuminate the blind spots along your financial path. Whether you’re saving for an emergency fund, planning your retirement, or just managing your investments, our expert team can guide you to the right path forward. Get in touch today and start building your best future.