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Why You Need an Emergency Fund in Savings

by JS 


Establishing and maintaining an emergency fund was absolutely the last step that I took in getting out of debt. For the longest time, I thought that the entire concept was simply impossible. The thought of not only having all my bills paid off, but also having extra money was just unfathomable to me. In fact, it took my mother harping on me for years about this before I finally got around to doing it.

But it is an important piece of living a stable and sound financial life. An “emergency” could be anything: loss of employment, major car wreck, or major medical emergency. Nothing is worse than having to go through any of those without enough money to afford them.

How Much Do You Need in Your Emergency Fund?

Having an emergency fund is important, but how much should be in it? Many figures have been bandied about on the topic. Some say three months worth of income, some say six, and yet some say even more. Personally, I think you should have enough money set aside to pay your bills for at least three months. If you can get to six months, great, but I’d say three should be the minimum goal.

Where Should You Place Your Emergency Funds?

And now, for the $64,000 question—where do you place these funds? When I was first able to create my emergency fund, I was under the impression that it needed to be so accessible and liquid that I should simply hold it in cash under a mattress.

I later learned that while your emergency fund needs to be somewhere so that it is readily accessible to you at a moment’s notice, it certainly doesn’t need to be stashed away in some dark, hidden place where it’s just sitting there. You need to put it to work for you. What I mean by that is that it should be generating some kind of income for you while you are waiting for the day when you might need it.

Now, exactly where you put it is entirely up to you. There are a lot of great places to put your emergency fund including an interest-bearing savings or checking accounts or a short-term CD. Ideally, you should diversity your funds across a few different options. Ultimately, just make sure that it is generating some kind of income for you. Even if it’s in something that is gaining you minimal interest, at least its gaining interest! It is better than just letting your funds sit there.

Personally, my emergency fund is in about three different places. One place where I have a the majority of my fund is a high-interest checking account that is gaining me about 4% in interest. This accounts allows me both liquidity, accessibility, and virtually zero risk since the account is FDIC-insured. The second place that I have some of my money is in a 2-year CD that yields about 5%. The rest I have in a conservative, bond investment that gives me about a 6% annual return on my money.

In Closing

First, if you haven’t yet started an emergency fund, you really need to get started. Emergencies in life take many shapes and forms and it’s just foolish not to have some money parked away for these kinds of events. Of course, I would suggest getting all your other financial “ducks” in order before proceeding, including paying off any debts.

Second, put it somewhere where it’s working for you. Just because it’s an “emergency” fund does not mean that it can’t still be gaining interest for you. There are a million places where you can put it. Keep it in a safe and low-risk type of account, and even if that only allows you to earn less than one percent in interest, those gains are still very important. Why give up free money?

So, where is your emergency fund? Is it “working” for you? Your comments and suggestions are appreciated below.

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Comments

2 Responses to “Why You Need an Emergency Fund in Savings”

  1. John on May 31st, 2012 10:26 am

    I agree with you and think that three months of expenses in an emergency fund is enough. However, I do keep six months of expenses set aside for emergencies because I’m self-employed. :)

  2. Jeremiah on August 27th, 2013 4:22 am

    I personally have our emergency fund invested in different index funds. Since we are young I don’t mind allowing for some up and down fluctuations in our account, and am hopeful that over 5 or 6 years having money in index funds will help us to grow those funds to a level that would cover 3 to 6 months worth of living expenses. I certainly understand where you are coming from when you suggest keeping your emergency fund in safer investments such as bonds and CDs.

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