You Need An Emergency Fund

by mike on March 25, 2011

What happens when your transmission goes out on your car?  What about the furnace in your house?  How do you pay for those emergencies?  Unfortunately, for most people in the United States, credit cards are your emergency fund.  Most people rack up credit card debt due to emergencies.  I have a better plan: build an emergency fund.

The first question you most likely have is how much is enough in your emergency fund.  It depends on your situation.  If you are trying to get out of debt, then putting aside $500-$2,000 in a beginner emergency fund will be sufficient.  You don’t want too much in there so that you can use the money to pay off debt.  If you have nothing set aside for emergencies, however, then you will use debt to pay for that new transmission.  If you are out of debt, then I recommend putting aside 3-6 months worth of expenses.  So, if it costs you $3,000 per month to run your household, you should have $9,000-$18,000 in your emergency fund.  Which amount you lean towards is up to you, but it should mostly depend on how secure your job is.  The main reason for the large emergency fund is to sustain your household in the event you lose your job.

Your emergency fund is not an investment.  The idea behind it is not to make money.  I know it is hard to have that much money just sitting around not doing anything, but it is there for emergencies only.  I recommend putting it in a money market account with check writing privileges.  During normal economic times, it will make more than just a regular bank savings account and is still very accessible.  You can talk to your financial advisor about opening a money market account.

If you want to have a strong financial plan, an emergency fund must be a part of that plan.  It will prevent future debt and give you a huge sense of security.  What you’ll find is that once it is there, you will rarely need it.

What are some financial emergencies you have experienced?

Photo credit: Ben Spark

 

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