Frugal Living

Emergency Fund

Emergency FundPlanning for emergencies in today’s economy requires that you be prepared for two different kinds of emergencies. The first is what typically comes to mind:

  • The unexpected $1,000 car repair.
  • Emergency room visit for your child not covered by your deductible.
  • Visit to an ailing family member with airfare booked for tomorrow.

Typically these things go on a credit card at interest rates that crush your budget. Saving for these emergencies is, and should be, a top priority. Maintaining an emergency savings account may be the most important difference between those who manage to stay afloat and those who sink in debt. The twelve million American adults that use payday loans annually would probably not have to take out eight loans of $375 each per year. The APR for a credit card runs 12 to 25% and a payday loan runs 300 to 700% with the average being around 400% for the APR. If you kept $500 to $1,000 of savings for these emergencies meet these unexpected financial challenges this would be much traumatic.

The emergency fund not only provides you with the money to pay for these expenses, it gives you “peace of mind” knowing that you can afford these types of financial emergencies.

Emergency Savings: Emergency Funds

The emergency fund is usually best kept in a bank or credit union savings account. These types of accounts offer easier access to your money than say certificates of deposit, U.S. Savings Bonds, or mutual funds. Though these are useful tools for long-term saving, they are not ideal for an emergency fund that you may need access to more quickly.

Keeping your money in a savings account makes it much less likely that you will use these savings to pay for every day, a non-emergency expense. That’s why it is usually a mistake to keep your emergency fund in a checking account.

Best Ways to Grow Your Emergency Fund

The easiest and most effective way to save is through an automatic deduction. This is how millions of Americans save at their bank or credit union. Your bank or credit union can help you set up automatic savings by transferring a fixed amount from your checking account to a savings account.

Other Sources for Your Emergency Fund

There are many places to find money to save. Start with the loose change you accumulate. Americans typically save more than $100 in loose change each year. Use this change to open and grow a savings account. If you receive a tax refund or Earned Income Tax Credit, use a portion of this money to begin or increase savings. Since the Tax Credits average nearly $2,000, you may be able to open a savings account and still have plenty of money to pay off debts or cover other expenses.

Other Sources of Money to Build Your Emergency Fund

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Emergency Fund: Loss of Employment

Your emergency fund should also be constructed so is large enough to cover three to nine months’ worth of expenses should you lose your job.

The agreement among financial experts is that everyone needs an emergency fund, a savings account with readily accessible cash to be prepared for any contingency that includes losing your job. The question is: How much should you keep in a rainy-day fund?

With more than 5.5 million Americans unemployed for 27 weeks or longer, according to the Bureau of Labor Statistics, the rule of thumb that was three to six months’ worth of expenses may no longer apply.

Experts are now starting to recommend that everyone keep nine months to one year of income in an emergency account in case of job loss. People are often out of work now for as long as nine months, and if they don’t have savings, they live on credit. Again, the APR on a credit card is 12 to 25%. So when you finally have income from a new job you are behind because you have debt to repay.

Here is the sad news: According to Bankrate’s February Financial Security Index, just a little more than half, or 54 percent, of Americans said they have more money in emergency savings than in credit card debt. One in 4 Americans has more credit card debt than emergency savings; this is up a bit from 23 percent last year.

Don’t Underestimate Your Monthly Expenses for Your Emergency Fund

It is so common to underestimate monthly expenses or not including everything. Families with kids and one income need the maximum emergency fund, while retirees who face an emergency but have a pension, Social Security and low expenses may need as little as three months’ worth in an accessible fund.

The factors that impact the size of your rainy-day fund include your living expenses, whether you have one or two incomes, and whether you have income from other sources such as investment properties or other income-producing assets. If you have two incomes and are good at budgeting, not spending every dollar that comes in, you might be OK with a smaller emergency fund.

Where to keep your cash for Your Emergency Fund

You should consider separating your savings into several accounts so you can more easily track your goals. One could be a rainy-day fund for small emergencies such as unexpected car or home repair bills. Others could be for catastrophe events such as job loss or a major illness.

I use a credit union because they are federally insured, safe, and mine offers a higher interest rate than a bank. They require that I have a debit card, do my banking online, and have direct deposit. While offering the potential of earning interest this is actually minimal.

If you need $5,000 per month to live on, that’s $30,000 you’ll need to have for a six-month emergency fund. That may be too much money to put aside someplace that’s earning as little interest as you do in a savings account.” One option would be to put four months’ savings in a conservative bond fund while keeping two months’ in a liquid savings account or money market account.

Another option is laddering certificates of deposit so they mature at different times, which adds a measure of liquidity to the money in those CD accounts.  It may be worth taking the risk of the penalty you would incur in an emergency if you can earn a better interest rate with a CD.

Everyone needs some amount of liquid cash in case something happens.

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