There is a LOT of importance placed on the almighty EMERGENCY FUND! There are also a LOT of opinions on how much you need, where to save it and when you should even access it. Well, fear not. This article is to answer your 5 burning questions about the emergency fund.
1. What is an Emergency Fund?
According to Investopedia, “An emergency fund is an account for funds set aside in case of the event of a personal financial dilemma, such as the loss of a job, a debilitating illness or a major repair to your home. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to draw from high interest debt options, such as credit cards or unsecured loans.”
Sounds pretty important, right? What’s scary is that based on a survey by Bankrate.com, 4 out of every 10 Americans could pay for an “emergency” in the amount of $500! That means most of us, can’t. I know, that’s pretty obvious, but I wanted to point that out in case it didn’t sink in. That means 60% of us couldn’t buy a new set of tires or replace your air conditioner!
A common choice for homeowner’s insurance is to choose a 5% deductible. If you own a home worth $100,000 then your deductible is $5,000 before the insurance company would even consider paying for damage to your home.
The Emergency Fund can be looked at as a form of your own “self insurance”. A way to cover an expense, up to a certain amount, without it putting you in a tough spot.
2. Who Needs an Emergency Fund?
Based on the definition above, everyone.
3. How Much Do I Need in My Emergency Fund?
This is where you may have heard the most “noise”. The common message out there is that you need 6 months of your expenses saved. While that CAN be true, it’s a simplification for the benefit of the general population. There is actually a little bit more to it than that, so we’ll break it down a little further…
First, think about your family and who relies on your income for their support. If you support anyone other than yourself, then you need 6 month’s worth of your monthly needs. Read this article on needs vs. wants to find out how to determine your “needs”. If there is no one to support but you, then you can go as low as 3 month’s worth.
Next, consider your insurance deductibles. We all have some level of insurance meant to protect us from financial harm (if not, you should!). The insurance company most likely shares the risk by placing a deductible on the policy to keep the costs down. You want to make sure your emergency fund at least covers your highest deductible.
Ok, to recap, you want at least 3 month’s of “needs” if you only support yourself, and at least 6 month’s if you support a spouse, child, or anyone else for that matter. Also, make sure you have at least enough to cover your highest insurance deductible.
4. Where Do I Keep My Emergency Fund?
The answer is ALWAYS IN CASH. NEVER invest your emergency fund. Here are a few places to consider:
High Yield Savings Account
This is probably the best place. Shop around and see which banks and other financial institutions offer the best rate. That being said, the most important thing is safety, not interest rate. Right now you can find something around 1%, give or take. Check out your primary bank, credit unions or even your credit card company to see what they have to offer.
Money Market Accounts
This is another option that could earn you a little more than a high yields savings account. This is about as far as you should go in the direction of “investing” your emergency fund dollars.
While this is an “option”, I hesitate to even bring it up. I will explain Roth IRAs in another article, but for now, just know that this is a retirement savings account that has some pretty great tax savings benefits if used correctly. If you decide to use the Roth IRA route, just know that you should be working with a financial adviser to make sure you don’t accidentally invest the funds or trigger penalties to the IRS.
To summarize, you want your emergency fund easily accessible and in cash. Consider putting it in a separate bank from your other assets to make it slightly out of reach. Use Bankrate.com‘s savings account comparison tool to find what rates are available. You search based on your location, deposit amount and account type.
5. Under What Circumstances Do I Use My Emergency Fund?
This is also somewhat of a debate. I’ve heard people say that it’s ONLY for when you lose your job. While that is one of the top reasons, it’s not the only one.
The emergency fund is there for unexpected expenses that you haven’t budgeted for. It’s virtually impossible (and not necessary) to save up for a car accident, a hurricane or some other freak accident that sets you back hundreds or thousands of doll hairs. What’s important though, is if you use it, you MUST replace it immediately. Stop all other savings until it’s back to the recommend value.
We place the importance of the emergency above your retirement savings. In my opinion, you need to protect yourself in the short term before you can save for the long term. You don’t want to have to go into credit card debt, because you didn’t build your emergency fund before saving for retirement. That will only lose you money in the long run.
Save between 3-6 months, depending on your situation. Place the funds in a high-yield savings account that is easily accessible and use it only for unexpected emergencies that you NEED to take care of right away. If you use it to replace a TV, you’re making a bad choice. If you cover your deductible because a pipe burst in your home, that’s a good choice.
Sports Fan, Movie Buff, and Anything Outdoors sums it up. Brad loves spending time with his wife, Ashley, and their two boys. He helps empower people to take control of their money, bringing them the confidence to build the life of their dreams.
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About Matt & Brad
They are identical twins and money experts. Matt and Brad Ruttenberg have, combined, over 2 decades of experience as financial planners. They are known for simplifying money and helping others go from living paycheck to paycheck to thriving financially.
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This communication is strictly intended for individuals residing in the states of Florida, Michigan, Arizona, Nevada, New York, Ohio, and South Carolina. No offers may be made or accepted from any resident outside the specific states referenced. Registered Representative Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. The Money Twins and Ruttenberg & Company are not affiliated with Cambridge.