The first step in every good financial plan is an emergency fund. It doesn’t matter whether you have a net worth that is negative or over $10 million. An emergency fund is a set amount that is designed to handle unexpected expenses or events. It can also be viewed as an amount that makes you feel safe. An emergency fund may be viewed as the strong base for your financial future or the umbrella that cushions all your financial activity.
There are two primary ways to view an emergency fund:
- Unexpected Expenses or Events, such as
- Temporary loss of employment
- Home or car repairs
- Medical or veterinary bills
- Safety Amount. An amount that helps you feel secure if the stock market has a major decline.
The amount you should have in an emergency fund varies for all individuals and the comfortable amount will likely change over time as well. A few key considerations when deciding how much to set aside include:
- The stability of income sources. Retirees living off social security have less likelihood of losing this income source versus individuals still in their working years.
- Does your household rely on one income or are there multiple income sources?
- The number of individuals that are supported.
- Your ability to handle fluctuations in the stock market or other investments.
A typical rule of thumb has been 3 to 6 months of living expenses. For some individuals, however, 9 to 12 months may be more comfortable. To start, new homeowners or young savers may target $2,000 or $5,000 to cover unexpected home or car repairs. From there you can build an emergency fund that is most comfortable for you.
The best place to hold an emergency fund is in a bank insured by the FDIC. If possible, an account that is generating more interest than a checking account would be good. This may include a high yield savings account, CD or combination of both. The most important thing is accessibility. Make sure the funds can be readily available without little penalty if needed. CDs typically have some penalty if funds are withdrawn prior to maturity; however, it is often minimal. Be sure to understand the terms of any account before entering into an investment.
It’s always a good time to review your emergency fund. Is now a good time to build this up to be prepared for the next unexpected event? Or do you have more than enough at the current time and need to put some cash to work in the market?