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About 4 minutes
Being smart with your money means being prepared for what life has to throw your way. That’s why one of the first and most important steps in healthy financial living is building up an emergency fund.
Your emergency fund is there to protect you from things like a lost job, sickness, unexpected home or car repair, or unplanned travel (not a vacation).
Sooner or later, something will catch you by surprise. And if you aren’t prepared, you’ll find yourself scrambling to find money. You may even be forced to rely on your credit card or other personal loans. Not a great option since it can leave you with high interest debt. And this can quickly turn into it’s own emergency.
If you’re already struggling with credit card debt or are having a hard time paying your bills, we know that trying to save money for your emergency fund might feel like a stretch, or even impossible. But even saving a small amount can make a big difference when the time comes.
How much should I save?
There’s no exact answer for everyone, but a common rule of thumb is that you should have at least three to six month’s worth of living expenses on hand.
We realize this can be a lot of money, especially if you’re starting out from scratch. So you might want to approach your emergency fund in stages. For example, you could set a goal to first save one thousand dollars. Then try for one month’s worth of living expenses. Then, over time, increase it to three months, and then eventually build up to six.
Long story short, you don’t need to think of it as an all or nothing prospect. Having any money in your emergency fund is better than having none. When you hit each stage, you can re-evaluate your financial situation and decide how best to allocate your savings across competing goals.
Where to keep it
You’ll want your emergency fund to be accessible, or liquid. A good option is a savings account at an FDIC-insured bank or at an NCUA-insured credit union. (Most banks and credit unions are insured, you just want to make sure.)
While a checking account would also keep your money accessible, you likely won’t earn any interest on it. So you’re generally better off with a savings account. Your checking account is intended for more day-to-day type transactions, like paying bills.
And it’s a good idea to open a separate account specifically for your emergency fund, and maybe even at a different bank from where you have your checking account. Remember, you want to keep your money stashed away for emergencies. Creating a little separation might make it less likely you’ll dip into your fund for non-emergencies.
If you want to learn more about setting up a savings account, we have you covered.
What about investing it in stocks?
While you could, in theory, invest your emergency fund (or some of it) in riskier assets like stocks or bonds and earn a higher return on your money, it’s generally not recommended.
Unlike money in a savings account which is stable from one day to the next, money invested in stocks and bonds will fluctuate with the market, and can go down in the near term (even though it’s likely to increase over the long term).
Also, when an emergency does arise and you need the money, you would need to sell some of your investments, which means you may need to pay capital gains taxes. In other words, you may not actually have as much money as you think you do. For the most part, it’s simply best to keep your emergency fund in a savings account.
Grow and protect your fund
Once you’ve set your target amount, figure out how much you’ll need to contribute each month and factor that into your saving strategy.
If you’re having trouble staying disciplined, you might find it helpful to write out monthly bills to yourself in advance and then force yourself to put them towards your fund. Or better yet, you could consider setting up direct deposit, or automatic payments, from your employer to your fund. That way, you can take your will power out of the equation entirely.
Finally, once you’ve worked hard to build up your emergency fund, protect it. Diligently. Don’t be tempted to spend the money on a vacation or other non-emergencies (even if a vacation feels like emergency status). Set aside separate money for your fun purchases. Your future self will thank you.
1) Building up an emergency fund in advance of needing the money can make the difference between weathering financial emergencies and hardship.
2) It’s a good idea to have six months of living expenses on hand, but if that’s too much for right now, you can set a smaller goal and then revisit later.
3) To play it safe, keep your emergency fund in a cash account, like a savings account.
4) Build up your fund over time by forcing yourself to contribute to it regularly.
5) Save your emergency fund for real emergencies only.
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