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Life doesn’t always go to plan. Cars break down, kids have field trips and kitchen appliances need repair. In more extreme circumstances, layoffs happen, health problems arise and family members need urgent financial help. The best budgets account for the inevitable financial potholes of life, no matter how big or small.
While we can all agree on the importance of savings, things get complicated when it comes to the details of how much to save, how fast we should save it and where we should keep the money we’re saving – especially when we aren’t exactly sure when we may need it or for what purpose. Here are some tips to help you get your emergency fund started.
How Do I Get My Emergency Fund Started?
The fastest and easiest way to get started with your emergency fund is through automating it. Whether it’s sending a portion of your paycheck to a savings account via direct deposit or setting up an automatic transfer from your checking account, it’s always smart to keep your emergency funds saved somewhere that isn’t too easy to find next time you’re shopping.
The key to reaching your savings goals is consistency and realistic expectations. Starting a habit of saving $50 a month becomes $600 a year and saving $100 from your bi-weekly paycheck adds up to $13,000 over five years. Focus on an amount that is reasonable, sustainable, and that doesn’t take away from your ability to cover your usual expenses.
How Big Should My Emergency Fund Be?
The ultimate goal should be to put aside six months’ worth of your expenses or income into your emergency fund; that amount would typically cover critical expenses like housing and utilities, food, debt, etc. for a reasonable amount of time. But that goal amount can range from three months to a year depending on how high your insurance deductibles are, how easy it would be for you to secure a new job if needed, etc. Here are some important questions to think about when determining how big your emergency fund should be:
- How long would it realistically take to find employment if you are laid off?
- How large are your deductibles on car and homeowners insurance?
- Does your employer provide short or long-term disability insurance?
- What does your medical insurance plan cover and what gaps exist?
- Does anyone else in the family have additional sources of income or access to health insurance that could subsidize expenses, if needed?
Your answer may be different than your friends or family members, so take the time to figure out what is best for you and your circumstances to be prepared.
Where Should I Keep My Emergency Fund?
Only you can determine how much risk you can stomach with your finances. While it’s often a good idea to keep your emergency fund in a vehicle that accrues interest so your balance can earn while it waits, most experts suggest maintaining some level of liquidity with your emergency fund. Liquidity is access to cash in case an emergency happens and you need that money to pay your bills fast.
Keeping your emergency fund in the wrong place isn’t the end of the world, though. Bonds can be liquidated, and stocks sold, but paying penalties for early withdrawals or taxes on sold stock can be a momentum killer or take away from the funds you’ve saved up.
While it’s always a good idea to get investing advice from a financial counselor and tax advice from an accountant, here are some options to mull over:
- Money Market Account: All money market accounts are insured, and some even have check writing privileges to help make them more accessible. While there may be variable interest rates available, they still typically offer lower returns than CDs and money market mutual funds and may require a high minimum balance.
- Money Market Mutual Fund: Much like money market accounts, these funds offer some checking privileges and are lower on the risk scale compared to other mutual funds but could offer a better rate of return. Unlike traditional money market accounts, money Market mutual funds are not insured and often require a large initial deposit.
- Savings Account: NCUA- or FDIC-insured financial institutions insure your savings account up to $250,000 and may have higher interest rates than a checking account. The current return on savings accounts is considered by many as particularly low, so it’s up to you to determine if the security of your money is paramount. It’s also important to know that savings accounts may be slightly more difficult to access money from than checking accounts, as they often require you to transfer them to your checking account or come in person to withdraw the funds.
- Savings Certificate (CD): If you are looking for an insured, fixed-rate savings vehicle this may be a great option. Just remember that fixed-rates mean you won’t benefit if rates go up. As a termed account, you are agreeing to the leave your money for a set amount of time (months to years typically) and an early withdrawal may result in a penalty.
- Checking account: They are typically the most convenient, the easiest to use, and insured. They generally require a minimum balance and may carry low interest rates, but some credit unions and banks like Firefly offer free checking options with higher-interest rates in exchange for meeting certain requirements.
- U.S. Treasury Bills: Often referred to as “T-Bills,” U.S. Treasury Bills feature competitive interest rates, are guaranteed by the United States Government and are exempt from all taxes (state and local). The down side to Treasury Bills is the difficulty in liquidating them.
- U.S. Series EE Bonds: There is flexibility regarding the fixed or variable interest rates on EE Bonds and they are very easy to redeem at any credit union or bank. Like Treasury Bills they are exempt from taxes, but be aware that interest only accrues on EE Bonds twice a year and there’s a penalty for redeeming your bonds before five years of ownership.
- Paper Envelope: Going old school and saving your money as cash in an “emergency fund” envelope is certainly the most accessible way to save, but it can also be incredibly risky. That money isn’t insured against theft, fire, or natural causes so when it’s gone - it’s gone. You also don’t accrue any interest on the cash as it sits in that envelope therefore losing value each year as the value of a dollar decreases.
No one wants to plan for the worst-case scenario, but starting to save now can greatly reduce the stress of managing your finances during tough times and should help make those unfortunate moments of life a bit more manageable.