Personal Finance Advice

You have probably heard the term emergency fund thrown around by financial advisors and experts, but maybe you have wondered what the term actually means.  Is an emergency fund a bit of cash stashed away somewhere in a safe, or is it a huge amount of money deposited into a savings account somewhere? What do you actually use your emergency fund for? What qualifies as an actual emergency?

An emergency fund is actually a pretty simple idea.  Here are the basics:

1.  An emergency fund should be separate from your other accounts.  Don’t embed your emergency fund within your checking account or another savings account.  The money you have designated as an emergency fund should stay separate from your other money because you don’t want to tempt yourself to tap into your emergency fund for an everyday purchase.  You’re less likely to dip into this account if it isn’t already attached to all your other money.

2.  An emergency fund should have enough money in it to cover you for at least 3 months worth of expenses.  The point of an emergency fund is to cover you in case something happens and you can’t cover your expenses.  Three months is a good amount of time to have sufficient money for living expenses because this should be ample time to find a new job in case of a layoff or to cover the cost of something expensive like an auto or home repair.

3.  An emergency fund shouldn’t be hard to get your hands on.  Although you don’t want your emergency fund to be so accessible that you are tempted to dip into it for everyday purchases or indulgences, you don’t want the account to be so tough to get your hands on that you can’t access your money when you actually need it.  A good bet is a money market account that allows you to write checks to access the money.

4.  An emergency fund should earn interest.  You may as well earn some interest if you’re going to have a chunk of money sitting in an account.  Even though you aren’t necessarily using the money for anything at the moment there is no reason why the money shouldn’t work for you a bit. 

Remember that an “emergency” is defined as anything that arises that you can’t avoid paying for, yet you don’t have the money to cover the cost without using your emergency fund.  This could mean an unexpected medical bill or some cash to cover costs if you make an error on your check register and wind up with a couple hundred dollars less than you thought you had. 

Replenish your emergency fund if you use it, and keep adding to it until you have three months worth of expenses.  Try to work up to having six months worth of expenses in your account.  It’s okay if it takes you quite a bit of time to get your emergency account funded to adequate levels.  After all, putting $20 a month into a savings account for an emergency fund is far better than not putting in any money at all.