All You Ever Wanted to Know About Emergency Funds (But Were Afraid to Ask)
Published on - November 19th, 2008 (by J.D. Roth) This is a guest post from Dylan Ross. Dylan is a long-time member of the Get Rich Slowly community: a frequent commenter and occasional guest author. He’s also a Certified Financial Planner. This article is an abridged version of a chapter Dylan contributed to Investing in an Uncertain Economy for Dummies, which was recently published by Wiley. See the end of this post for a chance to win a copy.
Even if you’ve never had to quickly come up with money for something you weren’t expecting, you always face the possibility of needing money in an emergency. Emergencies are unplanned expenses that require more money than you can cover with your paycheck, even if you cut some expenses until next payday. When you don’t have enough in savings, emergencies can put you in debt or deeper in debt. An emergency fund helps protect your finances.
Unexpected expenses may be one-time or recurring. Potential uses for emergency funds include car repairs, paying bills if you’re out of work, large medical costs, insurance deductibles, critical home repairs, legal defenses, travel to attend a funeral, natural disasters, and so on.
Figure how much to set aside
At an absolute minimum, set aside enough money in your emergency fund to pay for at least three to six months of basic living expenses (the regular and essential expenses you must pay to live). These expenses don’t include discretionary items like entertainment, dining out, or spa treatments. Keep at least six months of basic living expenses in your emergency fund if you’re single or living on one income, or if one income in your two-income household varies a lot from month to month or isn’t secure.
Your emergency fund does more than just cover expenses in case you lose your job, so resist the temptation to keep less in savings. If you anticipate more frequent or more severe emergencies than three to six months of basic living expenses can cover, increase the size of your emergency fund. For example, you may need a larger emergency fund if:
- Your job security is questionable.
- You’re about to have a baby or purchase a new home.
- You have numerous aging household appliances.
- You drive an older car.
- You live in an area prone to severe weather, earthquakes, or other disasters.
- You engage in activities that may require frequent trips to the emergency room, doctor’s office, or the first aid aisle of your pharmacy.
Your emergency fund is also handy when you need to make insurance co-payments or pay for charges not covered by a health, dental, or vision plan. Sometimes you may need cash until you’re reimbursed by an insurance company or flexible spending account. Consider any unreimbursed medical expenses from the past few years when deciding whether to increase your emergency fund.
If you’re feeling especially uncertain, add to the size of your emergency fund. You can always reduce it after you’re through a rough patch.
Handle your emergency fund with care
The tricky thing about financial emergencies is that you don’t know what they’ll be, when they’ll happen, or how much you’ll need in order to cope until you can recover. All these unknowns make your emergency fund an important part of your financial profile and one that you should treat with special attention and care.
Make your emergency fund a high priority. The harder you think it is to come up with money for an emergency fund, the more you need one. If coming up with money to start an emergency fund now will be a sacrifice, imagine how tough it will be when you have to pay the costs of an emergency situation.
If you’re trying to pay off credit cards or high-interest loans, start with an emergency fund that could cover one month of basic living expenses. After you save one month of expenses, put extra money toward your debt payments. When your debt is paid off, build your emergency fund as quickly as possible. Otherwise, a sudden emergency could send you right back into the red.
Keep your emergency fund in cash types of investments. This money should be quickly available with no risk of decreasing in value at any time. An emergency fund is self-insurance, not an investment. You want your money to be accessible, but you also want to earn some interest on it so that you offset inflation at least partially, if not completely.
Some places to keep your emergency fund savings include:
- High-yielding direct savings accounts. Online savings accounts often pay a higher than average interest rate. You can, and should, establish an electronic transfer link to your checking account.
- Savings and money market accounts. These are interest-bearing accounts at banks or credit unions. Being able to electronically transfer money to your checking account is best.
- Money market funds. Not to be confused with money market accounts, these are funds offered by mutual fund companies and brokerage firms. You redeem fund shares to get cash out. Some accounts allow you to write checks to access the cash.
- Interest-bearing checking accounts. These accounts pay less interest than savings accounts.
- Certificates of deposit (CDs). These banking deposits guarantee a specific interest rate if you hold them for a specified period of time. They aren’t an ideal place to keep your emergency fund money because you usually have to pay a penalty to get your money out early.
When deciding where to keep your emergency funds, make sure you know how and when you can access your cash. Can you get to your money after business hours? What about on weekends and holidays? Can you use checks, an ATM, or a debit or check card? Also, make sure you’re comfortable with whether or not the account is insured.
Don’t use available credit as an emergency fund! Credit cards and home equity lines of credit could serve as a backup to your emergency funds in the event of a catastrophe, but the whole idea of an emergency fund is to keep you form adding debt. Some emergencies could affect your ability to make minimum debt payments, and missed payments, late penalties, and finance charges can easily snowball out of control.
Use your fund wisely when the time comes
Sooner or later you’ll have a large, unexpected expense you can’t cover with your paycheck. First, decide whether it’s a real emergency. Do you need to spend the money right now? Can you make do until you can save up to meet the expense? Your answer may be influenced by other events. For example, if your dishwasher bites the dust, you may decide to save up for a new one while you hand-wash dishes because of layoff rumors at work.
When you face a real emergency, access only the minimum amount of money necessary to get you through the emergency. Cut any unnecessary expenses and direct any available income toward your emergency before accessing the emergency fund. When the emergency is over, rebuild your emergency fund as quickly as possible, before reinstating nonessential expenses.
Two book giveaways in one week! Strange, but true. This time I’m giving away two copies of Investing in an Uncertain Economy for Dummies. To qualify, you must leave a substantive comment discussing your approach to emergency funds. I’ll randomly select two five winners on Friday. Motorcrash image by Incase Designs.
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I just learned the hard way the need for an emergency fund. My significant other, an otherwise completely healthy 27 year-old, just had to have an apendectomy, while between jobs and between health insurance plans. When it rains, it pours!!
Thankfully, we do have a fairly well-padded emergency fund, and will probably be able to take this in stride!
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Great post! I think the tip about not using credit for an emergency fund is especially important. Too often we think of credit as “available cash” when it is really loan. While I have an emergency card for tight spots (especially when I’m away from home), I immediately pay it back with money from the emergency fund. Then start to build that fund back up.
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I think it’s best to pay off credit card debt first. I view having credit card debt as an emergency. Why save 3-4% when you can pay off debt that could equal ~20%. Calculate the interest rates of the debt and the guaranteed savings; and go from there. I like having a goal for my emergency fund. My emergency fund serves as a place to buy a new (or used) car. When I can afford to buy a car I want, then I have reached my threshold for the emergency fund. The remaining savings goes into lowest cost index funds. Then when you need a car, you buy it with cash; and start the process over again.
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If I have a maxxed out credit card shouldn’t I focus on removing that before building an emergency fund? That way I pay less interest and in desperate circumstances I can always use the credit card if need be
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You cannot over state the importance of an emergency fund. This is the pillow that protects you when you fall down.
There’s another interesting result of having a well funded e-fund, a lot of would be emergencies don’t seem that bad any more.
If you’re broke and the muffler falls out of your car, that’s a HUGE DEAL! If you had $10,000 in the bank, that gravitational muffler is reduced to an inconvenience.
Miranda makes a great comment above – credit cards are not the answer. Going into debt to pay for an emergency only compounds the problem. I would only suggest that she use high interest account with a debit card to replace her ‘emergency card’. Then you avoid the chance (however unlikely) that the bill doesn’t get paid, or is late, etc.
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In our emergency fund, we saved three months expenses because we knew a layoff from our company included at least a three month severence. Now we are getting to use it as my husband was laid off!
I will say it would have been better not to count on the severence for two reasons. First, it took about a month to receive it. Second, the taxes taken out reduced it by about 1/3.
A larger emergency fund would also have been better because we are in Michigan. In this economy, Michigan doesn’t have many businesses hiring, and other businesses are very competitive to get into. IE there’s a LOT of people applying, and they don’t need to pay as much or offer moving packages. A larger emergency fund gives you the freedom to move when you’ve lost equity in the house and need some towards a down payment for a house in a new location.
Fortunately for us, it looks like he’ll be accepting a new position in this area. So that severence payment will be added to our somewhat diminished emergency fund!
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I’ll go even further with the idea of an emergency fund. In conjuction with the emergency fund, there should be a plan of essentials and non-essentials expenses.
Depending on the type of crisis, the focus may not be on financials. If the crisis is taking an emotional toll on the family, adding the negotiations of essential versus nonessential expenses may result in no action or added stress.
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I’d like to add having some cash at home for emergencies i.e, locksmith; superintendent; groceries and prescriptions. backup prescriptions would be good too especially during travel.
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It’s important to separate your emergency fund from other savings you may have. In my case, I have separate accounts to save for for yearly/semi-yearly bills, home improvements, Christmas presents, etc. But all of those accounts are distinct from my emergency account.
I used to put all my savings in one slush account but it didn’t work out. It was too easy to spend the emergency money for vacations or new toys.
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I cannot stress one point enough from Dylan’s advice: having 27/7/365 access to the emergency funds is vital. Many online banks do not provide ATM access to the funds, thereby limiting their effectiveness as true emergency funds. I can say with 100% certainty that HSBC Direct does offer such a service (as I have an ATM card that is linked to my account).
@Ryan: If you have nothing saved for emergencies, then I would reccomend concentrate on doing both. While it is important to pay down debt, it is also just as important to build savings, particularly an emergency fund. There are no clear “rules” per se, just differing viewpoints. I am a believer, and tell my clients as well, that you should never have all of your money focused on any one specific goal. It is important to be well balanced, which means that not all of one’s monies should go exclusively to paying down debt, investing, saving, etc….it should be spread out with the emphasis on the most pressing issue. Depending on your specific situation you may want to figure what may be the best split for you (80% toward debt & 20% toward emergency fund for a loose example). Also please have a look at my blog post, Be wary of advice from forums and blogs regarding taking advice from blogs and forums at face value.
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There’s an additional disadvantage to using a credit card or HELOC as your emergency fund: you don’t have control over that money. Just ask the people who had their HELOC access cut off because they were laid off. So much for using the HELOC as a backup for unemployment!
Ryan: some credit card companies have begun “following down” as people pay off their cards. For example, say you have a $3000 credit limit and $2800 in debt. Pay off $400, and your debt is $2400… and they lower your credit limit to $2600. You still only have $200 in available credit, even though your balance is lower.
You can’t count on having that available credit after you’ve made a payment, because you can’t guarantee that your credit card company will keep your limit where it currently is.
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Mr. McLean, poster #3, NO! Build up that emergency fund first. That will help keep you from having desperate circumstances. A maxed out credit card is not an emergency, it’s usually buying too much crap or needing to work harder and earn more. Believe me, it’s a much better life when you live debt free. It’s not easy at first during the learning phase but it gets better as you persist.
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I keep two emergency funds–one for car repairs etc. which is in a money market fund and one for “unemployment insurance” which is in laddered 6-month Treasury bills (CDs would work as well). I have six bills in the same amount (which I’ve increased gradually) and automatically buy one every month (I keep money in my savings account so I have enough to buy the new one even if the old one hasn’t matured yet). All I have to do is cancel the buy order and I have a monthly income for six months (or cut it in half and have a low monthly income for a year). The interest rate isn’t great, but of course it beats the -30% or so my equities are earning right now.
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I take the paranoid route to emergency funds. I like to have what I call my “rainy day fund” with 6 months of expenses. I do everything possible to protect this fund. The only time I would ever deduct from this fund would be the result of a dire situation such as the loss of a job.
To protect my “rainy day fund” I have created additonal emergency funds that are more focused and smaller in value to protect me from the more likely problems I will encounter from day to day. I have a car fund, house fund, and HSA fund. These funds have < 5000 in each of them and will cover most repairs that may arise from problems with my house, cars, or health.
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CD Ladders are an excellent method to earn a decent amount of interest on your emergency fund. I would suggest building up a 6 month stash in a high-yield savings account (a la ING Direct) and then proceed to keep it in a rotation that allows for you to have 2 months worth of savings liquid while everything else is maturing.
@Ryan McLean: IMO, an emergency fund should be one of the first things you do before you try to tackle debt. While you should continue to make timely monthly payments, I would suggest that you save up at least $1000 to hedge against future emergencies. Using your credit card for emergencies is an assured way to discourage you on your trek towards eliminating debt–but having some backup savings will keep you on track and give you a better sense of security in your efforts.
Make your emergency savings + continued monthly payments first, then focus all your efforts on paying down your debt.
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My previous approach to an emergency fund had been to not have one. I thought I could use credit cards in case something came up.
But now with the shaky economy, and layoffs in the national media, it’s become a priority for me. I could sleep much better at night knowing I had 3-6 months of living expenses just in case something happened. I hate the thought that if I lost my job, I wouldn’t be able to pay bills (especially my mortgage) until I could find/start somewhere else.
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I agree completely with the need for an emergency fund.
Ours came in useful last year when my father-in-law fell ill.The only trans-atlantic flights available at short notice were business class. Having the fund meant we could go home without having to make the difficult choice of money vs. Family.
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I have a two-tiered “emergency fund”, and that system has really worked well for me so far. I keep $2,000 in a savings account with my primary “bricks and mortar” bank, and I can access that part of the fund with my ATM card, or transfer it (online) to my primary chcking. I can use that part of the fund to write checks for more immediate emergencies, like expensive repairs to my 8 year old truck or taking a trip to the Emergency Room (both of which happened this year).
The down-side to that easy accessibility is the low interest rate I get on my savings (a fraction of a percent per year). Since I now support a live-in fiancee (who is currently job hunting) and a mortgage, my “six months” number has increased. It would be nice if that money could make money, right? For that, I have an online, FDIC-insured “high yield savings account” that now pays 3% (though it has been as high as 5.75%, back when it was opened). It can take as long as 5 business days to transfer money to my primary checking, though in practice, it has never taken longer than 2, but at least I can put the larger chunk of my “emergency fund” to work. I also use this account for long-term and automatic savings, though I guess that’s a comment for another blog.
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An emergency fund is great. It helped us out several times. But the one comment is that every time I hear six months of expenses, I think it is impossible. People who do not have a fund should start with a smaller goal so they have a “more realistic goal”, like enough to pay a $500.00 car repari bill. Once that is saved up then think about the dollar value of a month’s worth of food added to the fund.
Here is why I say this. Back in 2005 I had an emergency fund of about 2 months living expenses. Then the shoes fell both at the same time. I was left go from my job. My wife was not working due to a health problem. Then two days after I lost my job, she found out she needed surgery. We had to keep her insurance under COBRA for the next 18 months. Yes very expensive. So out came the credit cards to pay for it.
Fast forward to 2008. My wife’s medical condition is still a problem. She is applying for social security disability. The company I now work for is up for sale. So in as little as six months I could be out of work again.
We were rebuilding an emergency fund but each time my wife needed a perscription or had another doctor’s bill it got wiped out. Our fund is now $600.00 but we have enough medical bills to wipe that out today.
The credit card debt we incurred in 2005 is about the same. We have been trying to pay it off but just when it starts to look better another medical bill is there.
Right now my wife is waiting for her appeal hearing for SS Disability. The wait could be a year or more we have been told by her attorney. She may have to go back to work to help pay off some bills but then she automatically loses her disability status. So she would have to apply again.
The future does not look brite but we keep trying to get an emergency fund. The $600 would pay for a car repair. Now we have to make that equal one months mortgage with escrow. It may take us a while but we will get there. In the meantime we just keep trying to Get Ahead in Life.
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This year is the first time I’ve ever saved for an emergency fund. Anything I’d ever saved before was for something specific, like a car, or Christmas, but just to keep from getting fees from my bank. Right now I have three months worth saved, but my sinking funds (I have an older car) need help right now. I’ve put everything savings-wise in ING. It’s made it a lot easier for me to maneuver and manage as I change my mind periodically on strategy (what kinds of funds I need). I’ve only been saving this way for six months. Fortunately, I haven’t needed to use it yet.
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I agree with the need to have 3-6 months of expenses in an emergency fund. My wife and I have been working on building our fund over the last two years in addition to paying the school & auto loans as well as the mortgage.
We have been using an ING savings account for our emergency fund. I like the idea of the laddered CD’s and will look into that. The other suggestion that we have started working on is the self-provided warranty account. This is a great idea to cover you when deciding if you should get the extended warranty.
We are about to find out if our emergency fund is enough to cover us. My wife had to stop work because we are pregnant with twins! Not only will we be missing the income, but we’ll soon have double the expense.
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Honestly, our approach so far has been not to have an emergency fund. We’ve had such high interest rate debts that we could not really justify having an emergency fund. I do not always think that it makes sense to have an emergency fund if you have debt with high interest rates. Any money you have in a savings account could be going towards the high interest debt. However, we are getting to the point where our high interest debts are almost paid off and will begin savings/emergency fund soon. Exciting!
Momma
Feature Blogger at Engineer A Debt Free Life (lots of money saving and frugal tips)
http://www.engineeradebtfreelife.com
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I recently had to extract my wisdom teeth and cost me hefty price for it even with my insurance covering. That’s when I start to realizing the value of emergency fund. I consider myself extremely healthy (never had any major surgery, no visit to ER) but I want to protect myself from unexpected event. So I set up an separate online account (ING) to deposit portion of my paycheck bi-weekly. I’ll learn to live without $100/paycheck and that money can come handy when (not if) my car breaks down. Thanks for the post.
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The article is really helpful. We have been working on an Emergency fund and have been considering a CD, but will probably stick to the Money Market account it is in.
Would it be recommended to have a totally separate account for the Emergency Fund or keep it with Short Term savings?
Also Donna makes a great point about having the essential and non-essential expenses planned out ahead of time, so when something would happen it does not add to the stress.
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Would a Roth IRA be a smart place to keep an emergency fund? I am 23,single with a student loan (~7% rate) and a car payment(0%). I have a pretty stable job and about 15k sitting in ING savings. So would it be smart to max out Roth for 2008 and 2009 and just have about 5k in online savings? or would it be wise to pay loans down sooner? Thanks
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I have had an emergency fund for nearly a year now. In fact, I now have three different emergency funds. Here’s how they work…
An “EMERGENCY FUND” for the serious emergencies. The AC/furnace breaks down, a cracked windshield needs to be replaced, a vehicular fender-bender, etc. These are mostly expenses that would be $250+. I started with $1,000 and $50 is added each month–all of which sits in a high-interest savings account. In the event that the EMERGENCY FUND needs to be tapped (not yet, knock on wood) the monthly budget will be adjusted to replace the tapped money.
Next, my “emergency fund” for those small month-to-month “pesky” expenses that are always there. The heating bill is $15 more than expected, the $25 wedding gift that was omitted from the budget, a car tire goes flat and needs to be replaced, etc. These are items under $250. This money is just “set aside” in my checking account and is always kept at $250. In my 8 months of using this method I have had as little as $23 and as much as $185 in one month to use–all of which was replaced the next month.
And finally my “stash” for the “old-fashioned” expenses. The road-side assistant, the small town diner, the taxi cab driver, etc. only takes cash. Generally small expenses that can be paid for by the $80-$100 I have “stashed” in my wallet because another payment method isn’t available (hence the “old-fashioned”).
There it is…a rather lengthy method to describe, but one that I have found to work for me.
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It is because of this blog that I have made personal finance a priority. Great post! Through this website, my fiance and I enrolled and survived (without strangling each other over our personal finance differences!!) Dave Ramsey’s “Financial Peace University” about two years ago. IT COULD NOT HAVE COME AT A BETTER TIME CONSIDERING EVERYTHING GOING ON IN THE ECONOMY.
If you are going to make the effort to have an emergency fund, you owe it to yourself to make a small investment in a quality personal finance education. That is your best emergency fund. With that, you make better decisions in the beginning to help cushion the effects of the unexpected.
Dave Ramsey mentions if you have debt, you need to first have at least $1000 cash for a beginning emergency fund. Then, you tackle that debt. Eventually you will need a 6 month emergency fund.
For the 6 month fund, I setup in INGDirect Orange Savings account (again, thanks Get Rich Slowly!) and into CD’s to protect against inflation. Since it is an emergency fund, you need to split it up so you have cash available when you need it without getting penalized for taking all of it out early. Invest in 1 year CD’s of $2000 each. Keep the first $2000 in cash in the Orange Savings Account so it is readily available. Believe it or not, the best part of the CD’s is that you will be punished for taking it out early, but not so mcuh if you need the money. That is a great deterrent to taking the money out to go by a nice new boat!!
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I’ve built up my emergency fund by depositing $x into another bank account that i don’t check very often every time my savings hits $y. this helps me for 2 reasons 1) i won’t spend the money because i don’t carry around the debti card for the other bank and 2) seeing my normal bank account with $y might make me feel a little flush and willing to spend while seeing $(y-x) makes me feel a little more like pinching pennies. but i still keep enough money in bank #1 to pay for normal expenses and the errant fee and i count some of that as part of my emergency fund.
I also think that not having a car means fewer emergencies to plan for.
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@Z:
A Roth IRA is not a good idea for an emergency fund at all. While it (or some other type of retirement vehicle) should be a part of your overall financial plan, that should be solely for retirement savings. An emergency fund should be liquid, and easily accessible at any time. As for the rest of your question, it would be very difficult to give an informed answer without having your specific financial information (ie: how much your monthly expenditures are vs. net income, revolving debt obligations, etc.).
I would also like to add that I have never believed in using a CD as an emergency fund. It is great for long-term savings, but the facts that it is not liquid, and you incur penalties for early withdrawal make it less than ideal. Even if you are laddering, there is only a 7 day window once the maturity day arrives, so your emergency will have to fall into that period, which as anyone who has ever had an emergency knows is never the case.
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One of the things I like about the Ramsay approach to debt repayment is that he pays attention to the emotional aspect of it all. Having an emergency fund allows you to pay for an unexpected situation without getting discouraged about your general plan. If you were to use credit for emergencies, you quickly forget why you spent the money, you just have to face that number at the end of each month and it can seem like you not getting ahead. An emergency fund keeps you feeling that you are still in control (as much as you can be) and that you are still moving forward.
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Personally, I’m not sure why a CD is the lesser option for an emergency fund. I think it should be one of the primary tools. First, it’s the only way you are going to get a good rate. Second, despite the title, very few people need instant access to their emergency funds. So there’s little reason why you couldn’t structure some sort of ladder and be able to work just fine with that. I’m not suggesting all funds should be tied up in CDs. I’m just saying that it is pretty dumb to not earn interest on a sizeable chunk of money that you know isn’t going to be touched unless it is an emergency. Plus, a CD makes it harder. I also have heard some mention the need for quick access. I realize there are some emergencies where you need the money instantly. But for the most part, every online account can transfer funds within 3-5 days. I can count on one hand the number of true emergencies where money is needed faster than that.
Personally, I use multiple emergency funds. A general one with a small amount that is just in a savings account, another one for my house that is in a money market and the main one (my income replacement fund) which ultimately will be in a CD ladder.
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Without ever calling it an emergency fund, I do actually have one. Being single, therefore having a 1-income household, I have more than 6 nett salaries on an internet account, which can be accessed within a day. A nett salary covers more than basic necessities, so I estimate I could live for 10 months to a year just on my savings. A credit card takes care of immediate payments, which I can refund two days later.
I guess my savings account officially is meant for saving up for big investments or traveling, but in reality I have all I need and I usually save up extra money before traveling. I use the savings account to store the money I don’t spend, basically. No purpose there. Even if I want to invest in a more expensive product, I take enough time to find out if I really need it and during that time save up extra money.
Also, I must explain I come from a country with very good social services: if I get fired or my contract expires, I can get unemployment funds. Everyone has basic health insurance and I have some extra dental work covered. I have insurance for legal assistance. The only thing I don’t have (yet?) is insurance for being disabled and as a result not fit to work. But then I can still fall back on national social security funds. Actually, I’m going to check this weekend what happens to my income should I become severely disabled and maybe reconsider the insurance thing.
This post also reminds me to invest some time in getting a good private pension fund, since I am now only in a collective fund and I am not sure if the social pension program will still be there when I retire. I just put it off because I am still under 30 and will switch from academia to business in 2 years.
So, all in all, I guess I have got short term emergencies covered! Let’s now invest in possible long term adversities.
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Thanks to you, and the commenters for the great tips. I just (finally) set up a budget where I save 20% of my salary. I’m working on saving 6 months worth of expenses, after which I’ll start saving for a down payment on a house, and car. I’m actually pretty excited about it, which is a little strange!
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I’ve got a question. . .
Most people suggest various amounts in an emergency fund- 6 months expenses seems to be a commonly suggested amount. What do you do when you hit that level?
My approach to saving for my emergency fund, retirement, and debt down-pay is to limit “fun” expenses to concentrate on these goals. I feel that if I had 6 months expenses saved, I would be pretty comfortable and could focus some of my EF savings towards retirement, or just my own personal fun.
At what point around here do people say, “my EF is well funded, time to use some of that extra cash for a vacation or new tv.”
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I have a couple of emergency funds. Firstly, my current (checking) account always has a “float”, which allows me to use my debit card for smallish emergencies. If I ever have to top up the float from savings, I make sure that money goes back as soon as possible, because my instant access savings is my main emergency fund. This currently holds about 1 year’s worth of living expenses, because I’m thinking about buying a house, so I’m not tying up funds in things like CDs at the moment. Usually it would be between 3 and 6 months. I don’t worry about having the whole 6 months, because I figure that 3 months would get me over any sudden hump, and if I needed more, I could pull it out of the less accessible savings. If I’m in that much trouble, I’d be prepared to take the interest hit for those withdrawals, but it’s a good way of making me think a few times about touching it.
I do consider my credit card as an emergency fund source. However, this is because I could use the card, and then the delay before I needed to pay it off (in full, obviously) would allow me to pull the money out of the more tied-up savings. So I’m not using the credit as free money, just as an advance on my savings.
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I’m having trouble deciding whether to bulk up my emergency savings or to fully fund my IRA this year. With the market as low as it is (and a long-term investment horizon), now seems like a great time to be putting money away for retirement. On the other hand, I don’t want to plunder my emergency savings too much.
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I am on the brink of reaching my emergency savings goal. It is mostly in an online savings account and partially in a checking account. The accounts are electronically linked, and I have transferred funds between them before. But this post makes me concerned – it seems that transfers between my accounts can take 3-5 days until the funds are available. Is this common? Perhaps I need to increase the amount I keep in my checking account (which pains me a little since it is essentially no interest).
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Several posters have pointed out the risk of using a line of credit as an emergency fund. There has to be a risk vs. reward calculation. Here is the Canadian example:
My mortgage rate is 5.15% fixed. Mortgage interest is not deductible, so the effect of pre-paying the mortgage is a 5.15% tax-free rate of return.
An ING savings account currently pays 3%. Interest in Canada is fully taxed as income at the taxpayer’s marginal rate (in my case around 40%), so the after-tax rate of return is only around 1.8%, and thus below the rate of inflation.
As a result, I have only kept a small emergency fund and pre-paid the mortgage whenever possible, as in doing so I am earning an additional 4% on those funds. Instead, I have a line of credit that I do not use for anything but that could act as an emergency fund if there is ever a job loss. In order to earn an additional 4% risk-free, it is worth to take the risk that one day I might have to borrow money at 7% for a few months.
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Hmmm, my emergency fund! Gee what does that mean to me???? Let me think!
Honestly, it means to me:
I can go about this would and live my life without having to worry where the money will come from when a TRUE disaster strikes me.
The toughest part is understanding the definition of disaster. That is the key.
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The key to building an emergency fund (and to savings in general) really comes down to the idea of “pay yourself first.” At the beginning of the month, with my first paycheck, I automatically deduct a set value and put it in the emergency fund (an online high yield savings account). Then, at the end of the month, once I’ve paid rent, utilities, and credit card, I can put the leftovers in the emergency fund too! Double your pleasure!
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Having an emergency fund is huge. I’ve learned that the hard way since “Murphy” keeps impacting my family. It’s going to rain so you need an umbrella. We have a mini emergency fund and it needs to be larger. It has bailed us out over the past year and anyone who says you don’t need it is crazy.
– Andy
http://www.examiner.com/x-1181-Philadelphia-76ers-Examiner
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I think once you have some emergency funds set aside, some thought ought to be given to layers of protection. We should all have some cash on hand in case the emergency involves some type of disaster that closes ATM’s, makes processing credit cards impossible, or leaves no time for a bank run. I like having extra canned food, water, and toiletries available and consider them a required layer to an emergency fund as well. For the next layer, consider stashing some cash in a local bricks and mortar account with ready access. Then it becomes time to build layers like CD’s, T-bills, internet accounts, etc., for the larger yield to help beat inflation. While a Roth or I bonds could be part of this, consider the fact they can’t be withdrawn for a period of time without penalty, and in the early deposit period, can’t be withdrawn at all.
Personally, we spent four years building our emergency fund. Currently it covers a year of living expenses, because not only do we both work for the same company, but we are self-employeed in the construction industry.
We keep some cash in a safe, have a MM account at the local credit union with a debit card and electronic transfer to a checking account, then the rest of the money lives in laddered CD’s. While safety is an illusion, I do sleep better at night. It is a tough goal, it took us a LONG time to reach it, but it does bring peace of mind.
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I agree that an emergency fund is much more important than paying down credit card debt. While I have a bit of credit card debt, I am currently focusing on putting together one month of living expenses. After that I will turn my focus to my credit card debt.
I needed to get a root canal recently, but because I had no emergency fund, I had to get the tooth pulled. Even getting the tooth pulled nearly sunk me, and I had to wait to get paid again before I could have it pulled. Spending one day with a throbbing toothache was enough to convince me of the importance of an emergency fund. I also have been keeping a decent supply of dry goods on hand, so that if I get into a pinch, I can skip grocery shopping for a few weeks.
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While I don’t have a lot of data, I would suggest that much of the current wave of foreclosures in America is due to a widespread lack of an emergency fund. Emergencies can have extended lengths, or even pile on top of each other, and an debt instrument would be wise to avoid except as a last resort. Not only do you simply trade one type of issue (your present emergency) for a more long term issue (repaying your credit card, line of credit, loan, etc.), it is actually more expensive over time if you have to pay interest. As the author mentioned, I would regard debt instruments as a method of last resort only, to be used when you deplete your cash reserves. Even if you think you can afford payments with interest tacked on, how will your long term investments, retirement goals, and so on, be affected by an increased expenditure over time that you could have otherwise avoided?
As far as how much to keep in an emergency fund, my opinion is that you can never have too much in your fund. Reached 6 months income? Great, now make it 12. Any figure you use is arbitrary, of course, and there is no amount that is more right than any other. However, expect that emergencies will be far more costly than otherwise anticipated. As they say in Boy Scouts, be prepared! I would much rather have more money that I think I would ever use, and not have to draw my fund down significantly in any emergency, than find myself having to turn to debt to finance my crises due to not having saved enough in the first place.
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@ Nissal:
I think the point of having a CD ladder is so that your money is working harder for you–though your point on the short maturation window is noted. I find it acceptable then to use a credit card in emergencies that fall outside of that particular window. This makes sense as one will be able to make the respective payment back to the card in that time frame without incurring unwanted interest. On the plus side, one can also accrue rewards/cash back if using the appropriate card for the emergency at hand.
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I am currently putting my entire emergency fund in a 3% MMA with Captial One. I really like Dylan’s tip about self-insuring things. I would self-insure my car if I could! Also, if I know that I’m underpaying for something, I’ll contribute money to my MMA. For example, my DSL hasn’t billed me in 3 months, but I know it will eventually catch up with me. I see this as an arbitrage opportunity to gain interest on my money while I wait for AT&T to figure out that I owe them money! I would love to have a more sophisticated financial structure to my savings, but I am not sure where to start past an MMA.
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I keep my emergency fund in a high-yield savings account that is a bit of a pain to get to. This discourages me from using it unless it is a real emergency.
I have direct-deposit through work, and have a set amount go directly to my emergency fund. I follow the pay-yourself-first method. It is easy to save an emergency fund if you don’t really notice you are doing it.
Since my emergency fund is a hassle to access, and also due to the fact that I pay off my credit card in full, I use the credit card to pay for any emergency expenses. I then transfer the exact amount on my receipt / bank statement from my emergency fund to the account I use to pay off my credit card.
On the rare occasions that credit is not acceptable, then I will write a check and be certain to move funds over that same day.
This method keeps my hands out of my emergency fund except when actually necessary, yet provides me with instant access to ‘funds’ to see me through the emergency.
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As a person who has “operated” for 28 years of marriage without a true emergency fund, I can attest to the fact that if you do not have an emergency fund, you will find yourself more in debt as a result of not preparing adequately for these financial “emergencies”. I made the choice and decision weeks ago to contribute a specific amount dedicated for the emergency fund. For me, this was a milestone in deciding to do something to help produce a more secure environment for our family and to give us peace of mind in knowing that we have some security in building our emergency fund on a consistent basis. It has actually made us look forward to making that deposit into our emergency fund account because we can see the growth! This has become a way of life for our family now.
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We, too, have done Dave Ramsey, and been very glad to have that emergency fund. We have rather more than the $1000 basic one and a lot less than 6 months of expenses, but are still paying off some car loans. The thing that has amazed me is how few the emergencies have been since we had a fund in place!Dave calls it “Murphy insurance” and it seems he’s right when he says that Murphy just doesn’t come around when you are prepared for him!
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As a fresh college graduate with only around $1,000/ month of expenses I keep at least $5000 in my bank plus $4000 in well diversified mutual funds. For moral reasons I don’t invest in anything paying interest. In these times that’s certainly more risky but my moral code comes first.
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