A complete guide to emergency funds – Part 2
This is a two part post covering the following topics.
What is an emergency fund?
Why do I need an emergency fund?
How much do I need to save?
How to get started?
How to invest your emergency fund?
What are the common pitfalls of emergency fund and how to avoid them?
How to get started?
So you know how much you need in emergency funds, but do you have that much allocated?
If you are well covered, then that’s great. That is like a landmark achievement in your personal finance history…! Now you can feel more comfortable to face any surprises life may present you with however if the number you came up with overwhelms you, don’t get worried, now is the time to start to achieve that number.
If possible you should devote most of your savings in the next few months towards building your emergency fund. If that is not possible or that will not be enough, start small, say by saving 10% of your salary, by not eating out for some time or by cutting down on your daily addictions, whatever works for you and helps you save a little extra, even if its $10-20 a week. Eventually you will find ways to save more or earn more.
- Transfer these savings in a separate savings account or a designated checking account on a regular basis. This is very important. If you do not separate out the money, you may not be able to save more.
- Do not use the money in this account for any other purpose but an emergency.
- Keep setting small achievable targets for increasing the funds, if you miss the target think about cutting back on some of your regular expense to cover up for it.
How to invest your emergency fund?
Congratulate yourself for coming to a stage where you can think about investing your emergency fund. The key here is to keep your money accessible. Putting it in a designated high interest savings account or a designated high yield checking account is a good idea. This will help your emergency fund grow passively and you can focus on other financial goals.
Only if you have saved more than what you came up with as a number you need for your emergency fund you should consider other investments.
What are the common pitfalls of emergency fund and how to avoid them?
Resist any temptations to invest this money in stock market or mutual funds. Although they may be a good long term investment, they are very volatile in the short term and can lose you substantial amount of money. It gets even worse in times of economic turbulence when many people lose their jobs as well as take a huge hit in their savings which they had intended to use in case of emergencies.
Avoid putting these funds in long term certificate of deposits (CDs) as they are not very easily accessible and you may have to pay penalties to en-cash it before they mature.
Another common pitfall is that you may have created an emergency fund some time back and forgotten about it but as the circumstances in your life change, the amount of money you need in your emergency fund also change. So keep monitoring the amount you have in your emergency fund.
Rebuild your emergency fund as soon as possible after you have used some or all of it for an emergency. If you faced an emergency you would have realized how well this emergency fund served you, so if you have to; get started all over again.
Keep coming back to see tips some tips on how you can accelerate your savings and earn a little extra.
7 Responses
@ threadbndr: This is a great way to save your emergency fund. I feel I have done some injustice to the section ‘How to invest your emergency fund?’ I will update this section or this can be a good basis for a future article.
There is a great possibility of unexpected expenses for which you should keep some money as emergency fund. Post is giving great detailed knowledge regarding emergency fund, it will help the people who is having some less idea about it.
I would disagree just a bit with the no ‘CDs’. I certainly keep several (three) months expenses plus enough to cover my insurance deductables in totally liquid savings. But I do keep the rest of the “OMG, I lost my job” efund in laddered CDs with the maturities about a month apart.
If push came to shove, my credit union will let me use them as collateral for a personal line of credit, so I don’t even worry about the early cashout penalty. The more assets you have, the more flexibility you have. I wouldn’t look to any kind of fixed instrument (bonds or cds) until you have enough in liquid savings to prevent any loss of principle that an early cashout would cause.