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 have to say that having an emergency fund was such a relief when my husband lost his job in August. My parents gave me $5000 when I graduated from college and so I put a portion of it in a high-yield savings account. If we did not have an emergency fund, I would have stressed and freaked out over his job loss. Instead we made lemonade with the lemons and my husband decided to go to school full time.
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I’m the kind of person who uses a credit card for most expenses, but I always pay it off in full every month. It gives me a little cash back, so I use it for everyday things. I have an emergency fund, so therefore I feel OK using a credit card in an emergency because I can just pay off the extra charges on the card with the emergency fund money.
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In our house, we never really agreed upon an emergency fund. For the past two years we have been aggressively paying down our credit cards, and my husband did not see the need for an emergency fund: he felt it would take away from our debt repayments. I felt it would prevent us from adding to our debt. I admit that I did a bad thing: I hid some money in an envelope. I did sort of tell him about it, and if something had happened to me, he definitely would have found it, because he knows where I hide things.
In the end, he agreed that it would be good for us to get in the habit of saving, because now that we are close to getting out of debt, we don’t want to ever be back in debt.
So we started an emergency fund, mostly by increasing the cushion in our accounts. It’s pretty good for peace of mind, and when his sister’s car needed a repair while we were borrowing it, we could pay for it.
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It’s important to have a $1000 emergency fund BEFORE starting to pay down debt. Otherwise, any emergency that comes up will be paid for once again with credit.
1. $1000 emergency fund
2. Pay down debt. Smallest debt first and once done, snowball this payment amount towards the next smallest, etc.
3. 3-6 months emergency fund
etc, etc, etc
We’ve followed Dave Ramsey’s Financial Peace program and swear by it.
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Your Emergency Fund should NOT be an investment. Park it in a “secure” savings account or money market and leave it alone. After it’s fully funded, then you can start investing your other money.
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My husband and I are young-barely 23-but we have $20,000 in emergency money. You never know, and it allows us to be able to relax. Anything additional goes towards additional student loan payments (consolidated for low rates) and saving for a house, which we are well on our way to achieving. We drive crappy cars, rarely eat out, but we have more in the bank than any of our friends and waaaay more peace of mind even in this economy. I’m a huge advocate of this system.
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My wife and I handle our emergency fund a bit differently, and for the most part, it goes against many of the suggestions here, but I don’t personally see a downside. I would be interested to hear opinions.
Each month we make a payment on our home equity line of credit that is four times the interest charged that month. One quarter of that payment goes to the monthly interest, one quarter goes to paying off the principle, and the other half is our emergency fund. We keep track of how much of our payed off line of credit is actually the emergency fund so we know how much we have available.
The benefit in my eyes is that we have the emergency fund available, but if we don’t need it we have the advantage of not paying interest on that money.
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REASON BEHIND THE PLAN: I was sick and couldn’t work for about a year and a half. During that time, a hurricane hit, flooding my condo and car. I think that determining if a 3-month/8-month, etc., emergency fund is right for you is an excellent starting point for most people. But now that we are more comfortable with our finances and now that we are (mostly) out of debt, having an 8-month emergency fund (or however many months you choose), is not enough for us.
BREAKDOWN: We now want 8 months living expenses (we call this our “lose job fund”), plus $6000 (which is the most we would pay per year no matter if we use his company’s medical insurance or mine) plus $2000 to $3000 (for things the medical insurance won’t pay for) in a medical emergency fund, $500 for car insurance deductible plus $3000 for car repairs (one car is 10 years old) in the car emergency fund, $500 for home insurance deductible plus $1000 for miscellaneous house emergencies (appliances going out, etc.) in the house emergency fund. Multiple things can go wrong at the same time as I learned the hard way.
THOUGHT PROCESS: FYI, the reason we have multiple emergency funds instead of “the” emergency fund is 1) to make sure we keep enough money in there (car deductible may raise $500 and $500 against $20k isn’t something to worry about; but against $3500, $500 seems like a lot) and 2) since we will have all the money in one high yield ING account, it’s tempting to look at that $20k or so lump sum figure and spend it on a new car, etc.. Breaking the money down and thinking of it the way we do makes the money less tempting to spend.
PLACEMENT: We aren’t there yet, since we want to finish the student loans before we start (everything but the mortgage and student loans is paid). But this is our plan. We plan on keeping at least a $1000 for each fund plus one month’s living expenses in the local bank. All the rest will be in ING savings.
REPLENISHING: Also, even though most of the money is in a high yield account, it will never keep up with inflation so each month we will contribute “X” amount of money to the funds. In the event we do have a true emergency, our budget isn’t so tight that it takes a few years to build the funds back up again. If 100% of all emergency funds are spent, then we plan on being able to replenish this entire amount in about a 12-month time (barring future emergencies). And during this replenishing period, we plan on having adequate spending money. We plan on buying less house than we can afford in order to be able to do this.
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I am a big fan of starting small when overwhelmed by the prospect of accumulating a 6 month emergency fund. For my EF it has been a slow progression. Keeping a $20 in my car, maintaining a $1000 cushion in checking, automating a weekly $20 to our personal savings accounts were some of the small steps I took before becoming serious about having a true emergency cash fund.
Online banking and automating savings made it substantially easier for me to save more on a regular basis. Saving for a fun thing (trvel in my case) as I started to save for an EF motivated me.
Reading GRS made realize how lucky my husband and I have been. I feel like a dope after decades of depending on credit cards and more recently, our heloc for emergency funds. My sense of how much we need to have on hand has risen after reading the kinds of emergency situations have come up for GRS reader and also in recent events. Saving
has become more natural to me as I read about others struggling and doing the same.
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I just started reading this blog and am really enjoying it. Thanks!
As for the emergency fund issue…my husband and I both have good-paying jobs and fairly low budget lifestyle. As a result, we accumulated quite a bit of extra money in our personal and joint accounts, some of which was designated as an “emergency fund” in a money market account.
Now we’re in the midst of a divorce, and I’m facing the reality that much of my emergency fund cushion will be gone. I’d like to keep the house and if I do, will have to forgo keeping most of the money in exchange.
I also will have to adjust to living with a single income and the fact that I won’t be able to rely on a spouse’s paycheck as a backup if I am laid off or become sick and disabled, even temporarily. I find this rather scary, quite frankly.
But, if many of you who are in much worse situations can do it, so can I. I will economize even more and build up the emergency fund as my first priority.
I’ve previously thought about the CD ladder concept as an investment strategy and think I’ll give it a try once the settlement is done.
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I’ve just started our emergency fund, but I am not sure where I want to put it (yes, I have $1,000 in an envelope). I like the idea of added interest from an online bank, but I worry about access and I don’t know about how safe they are. How do you find out if a bank if a bank is reputable, ie not going under soon? (I know nothing, really!)
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I am finding it hard to build an emergency fund, as well. I have been trying to put money aside, but it’s so tight lately. choose to cut my food budget back to $15/week to try to save, as it’s the only part of my budget that is flexible.
Been trying to put extra money into the bank account that auto-pays my bills, so that if something does happen, i don’t have to worry about those right away. The rest, i’m just trying to build in my local savings account, transfering to my ING when i feel i have enough local for quicker emergencies.
I am glad to see the author of this piece suggest people only save up a month’s worth of emergency fund, before tackling their debt. Compound intrest can help you, or hurt you, depening on which side of the coin you’re on.
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TWoP Fan @154: Be sure to see if the online bank is federally insured. Even if it goes under, you will get your money back. When I’m looking to open an account, I go to bankrate.com, which does have a rating system. Is it accurate? I don’t know, but at least it provides some information. I linked my online account with my “brick and mortar” bank account so I can transfer money if needed. However, it can take several days to transfer. I have check writing privileges on my money market account so I keep $ in there, too, because of the access issues of the online savings. The interest rate on the MM is lower than the savings, but I like that it’s accessible.
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My wife and I have made a regular practice of contributing to a buffer fund every paycheck.
When I got laid off the first time, we found that it wasn’t so much the cash in the account that helped, but rather the discipline of living below our means.
When we re-structured our spending after the layoff, the first thing to go were our savings contributions, an absolutely painless adjustment.
When I got another job two months later we turned the spigot back on and away we went.
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so whats the differance between an emergency fund and an irregular expenses fund? are they the same thing or not?
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Right now I have our emergency fund (about 8 months of pared down expenses) in a money market account. I will be using this money to start twelve, 12-month CDs each coming due at about the first of each month in order to capture slightly higher interest rates.
My husband’s job is fairly secure, but we do only have one income. I’d rather be more secure than less so, so we will keep a one-year fund.
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@mb
An emergency fund and irregular expense fund are NOT the same thing.
An irregular expense fund is for items that you KNOW are coming, and probably WHEN. For example: car insurance (semi-annual), propane (I pay when it is filled, about 3 times per year), Xmas gifts, etc.
An emergency fund is for things that you DON’T know are coming: Your car needs non-routine work, you visit the E-room, you need a dental crown, your furnace quits, etc.
I have an irregular expense account that acts as a buffer to my emergency fund. Even though it isn’t scheduled I know I am going to need periodic work on my car, visit a doctor, see a vet, or replace something in my house. Some people consider these emergencies. I consider them inevitable.
So there is some grey area and how you bin these expenses is up to you, but the concept of an irregular expense fund vs an emergency fund are completely different.
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(Sorry for the length! I realised after I posted it how long it got)
I have been trying to get a grip on my finances, and after seeing the “grand total” of my college loan amount ((shudder)) I realized that I had no idea how to go about finances, or how I was going to pay back more money than I had ever seen in my life. I was not surprised to learn about an emergency fund I mean it seems like a good idea, but to me the amount always seemed to be 500.00 to 1000.00. Then I learned it should be 3 months salary MINIMUM. So I did a little research, I also have been supplementing that knowledge and altering my finance plan.
Currently I have an automatic draw of 10% of my paycheck routed into my savings automatically. I realized if the money isn’t there in my checking for me to spend I can’t spend it. Part of the problem was when I had direct deposit I would just sit on that amount, before I got it routed automatically into the savings. I would sit on it for weeks, and then when I would turn around to deposit it over into savings, it would make the month tight or I wouldn’t have the full amount. I also discovered that if you calculate your finances WITHOUT the money there, you are less likely to see it as useable income. (Even for loans or rent or food)
I had to also take a few months to notice my spending habits and understand what tricks work for me. I have tried a few methods and currently the automatic draw works the best. But I have also set a goal amount for my savings, and I look forward because it’s exciting to see that money grow closer to that amount. I plan to then start putting the additional cash to work I will save through my checking account after that goal amount is reached.
I think the hardest lesson for me and an emergency account was learning do to it without breaking the bank. I got so caught up in the desire and need to have an emergency fund I didn’t realize I was also hurting myself financially. That isn’t the goal of finance, you need to help your self out as much as you can at a time but also learn the financing method that works for you, without causing you so much financial strain you cant eat well for a week. It’s all about finding the balance between you, your spending and your savings.
I need to pay myself first and then re-pay myself later. Work up to my goal amounts and celebrate the milestones. I have had to borrow money out of my savings, but my goal is to pay it back over time, partly because I’m more borrowing the money from myself currently. It isn’t mine in the sense that I can use it at will, I have a strict mental association on it of “This money is set aside for me for emergency situations. If you keep spending the money how can you use it for an emergency?”
I have learned that finance is something that grows with you and needs to. You need to re-evaluate it every few weeks to a couple of months to ensure you are on track, have spending under control and are adjusting. I hope to eventually be able to put 15% of my paycheck aside monthly. Interestingly enough I learned more about personal finances when trying to set up an emergency fund, than just reading a book about it.
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Unfortunately I have learned this lesson the hard way. With no emergency fund of any substance, paying for a new heat pump, car repairs (timing belts, motor mounts, etc.) and coping with my wife’s reduced hours at work all at one time became a nightmare. My small emergency fund quickly vanished and was replaced with escalating credit card debt.
I make a good salary but the crunch felt from the credit cards could have been easily avoided with a better emergency cushion. I know that now and am on the way to digging out of the hole. Unfortunately, one of the pieces to pick up is a lost marriage as well. I am not suggesting an emergency fund can save a marriage but the absence of one can absolutely crush your personal finances in the event of an emergency we call life!
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This is a very timely post. I am recently remarried and while we both have secure jobs and a very nice household income, we are both sloppy when it comes to how we spend. What I mean is that money trickles away without us realizing where it’s gone. We’ve kept separate accounts but opened a joint account for the mortgage and home repair stuff. Well, we stocked up the joint savings account when we bought the house but since it’s been spent, we haven’t restocked it.
I am a CPA and knowledgable about money and savings but haven’t put that knowledge to good use. My new husband is much less knowledgable and also less disciplined.
I am going to show him this column in order to start the discussion I know we need to have. Luckily, there is only one piece of debt (we bought a pool last summer), no car payments, and no credit card debt. In this ecomomy it is truly foolish not to have a plan in place. Thank you!
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My husband and I began earnestly saving for our “future” a year before our wedding date – financial advice, etc. Our house purchase was planned for. Our son came earlier than we had expected. The medical complications leaving me unable to return to work full-time were unforseen. Eventually I left work all together to recover completely and did side jobs with my husband. I did find a better paying, full-time job in a different industry 7 months later. (Yay!) Needless to say, we burned through our fledgling savings, and my previous employer offered no maternity/illness benefits (to small), or IRA matches. Now we are trying to rebuild the savings, plus to pay the debt we incurred while I was “not holding my own”… And we have extensive maintenance issues that we put on the back burner for a while. I like the advice I’ve read here about “paying yourself first” and about various separate savings accounts. We’ve begun using Quicken to analyze how we spend our money and, hopefully, will be able to come up with appropriate percentages of paycheck deductions to accomplish each savings / repayment goal – esp. a renewed emergency fund. Our last big hurdle (hopefully s.t. you will discuss) is our Michigan mortgage. Yes – we were among those homebuyers who used the 0% option, since we had good incomes (that were going towards rent) but little savings. Now, our home is worth less than our purchase price, but we still can afford our payments – we just can’t afford to sell and move to a better job market.
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I actually found this article to be very helpful. I have always struggled between saving for the emergency fund and paying off my debt. I liked Dave Ramsey’s baby steps, but I was slightly uncomfortable with only $1000 in an emergency plan — that’s really one emergency! I liked the suggestion in this artcile of saving for 1 month instead of the 6 months, and then moving back to it once debt is paid for. It was a “duh” moment for me, “why didn’t I think of that?” Thanks for the post.
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This is the cut-off point for this article’s book giveaway. The numbers I’ve randomly generated are:
37, 69, 110, 128, 133
Which correspond to the comments here. I’ll e-mail the posters and arrange for shipment!
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If you are subsisting and have irreducible expenses, how do you build an emergency fund?
income: 908
rent (room in house with nine people): 650
medical exp: 110
student loan garnishment: 135
don’t see any way to reduce the expenses
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@Poor Boomer
If you can’t reduce the expenses, maybe you should try to increase the income. Get a second part-time job, find a new job, do odds-and-ends jobs to create more money–By just doing a $25 task each week you can build up an emergency fund faster than you would think. You never know what those types of jobs would lead to either. For instance, my uncle took on mowing lawns after his 8am-5pm job and within 3 months the “word had spread” about his services. He now runs a successful landscaping business with 3 crews.
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Wife and I have been building our emergency fund since March of 2008, and started with $300 in a MM account. Our goal is to have $12,000 saved, however whenever we crack the $7000 mark, something comes up that depletes the fund. We cracked the $7000 mark again last Friday, only for my wife’s car to blow out two tires. Now we’ve been told we need to replace all four tires, which will set us back $600. I find it annoying, but my wife keeps reminding me that if we didn’t have the money saved up, I’d REALLY be annoyed right now.
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Oh wow. 100+ comments! This is going to take me some time to get through – I have a question and I hope someone can answer this for me. After being deeply in debt with just a few hundred dollars in the bank, I managed to dig myself out of the hole and now have about $20k of savings spread out in bonds, and investments.
I don’t really like CDs as the interest rates are so low, and currently, in my country, inflation is about 7% and interest rates for CDs are about 3.5% at most.
With bonds at least I can match the inflation rate.
My question is this: is it a good idea to place your emergency fund in bonds?
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Oh heck … I realise that bonds have been discussed extensively in this thread. Apologies … and also, I realise that bonds sure work differently in the US. In Malaysia we can withdraw the money with a 10-day wait, and without penalty.
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After going through a transmission replacement ($2,100) with only a $1,000 emergency fund, I am so excited about the ability to have a real emergency fund. To me, it seems like freedom. For my fiance and I, 6 months of expenses will be $18,000. $18K! Once we have that much money set aside, most emergencies will be no big deal at all.
Transmission? No problem. Last-minute plane ticket? No problem. Water heater explodes? No problem.
Amazing.
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I have a mere five grand set aside as a pseudo-emergency fund. If I need more, I’m basically screwed at this point – compounded by the fact that I’m swimming in debt. I realize I need to build up my emergency fund first, so that’s where I’m putting my money right now – even though my debt-load is pretty large. I’m not sure I can ever get out from under this mountain of debt, but at least the wife and I are finally focusing on it and trying to take baby-steps.
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i leave my emergency fund in igobanking.com checking 3.80% APY for all banking needs except check writing and in bofi.com for check writing 3.40%APY
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My husband & I were always in sync financially. We both needed to put funds aside for an emergency. That emergency came when he became seriously ill and passed away after three years. Our emergency funds carried us though that. My biggest fear was becoming my sons responsibility. Because of what we put away in saving, IRA’s, ect, I should be able to maintain my independence and not live in fear. With a little planning (I’m learning) I should be able to continue to work my present job, retire in a few years and maybe even travel a little here and there. We enjoyed life but were frugal. We always thought and planned for a ‘what if’.
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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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