Do I need an emergency fund? The quick, easy answer is yes.
Unfortunately, that tends to lead to more questions such as, what is an emergency fund, why should I set one up, and where do I save the funds for it. Saving for a major life event can be stressful, so below are a few factors to consider for help.
What is an emergency fund?
An emergency fund is simply an amount of money saved up in the event that you get laid off or have unexpected expenses arise. The idea is that the fund has enough money saved in it to make ends meet should the need arise. It should also help to prevent you from maxing out your credit cards, and dipping into your retirement account.
This leads to the point that an emergency fund should be budgeted differently from your savings account. A savings account should be goal-oriented as in saving for retirement, college, a new car, or putting a down payment on a house. An emergency fund, on the other hand, should be used for events that cannot be planned for such as, losing your job, medical bills, or anything that would otherwise cause more debt. They do not have to be completely separate accounts, but you should know what is budgeted for emergencies and what is to be spent when you meet the goal you are saving for.
Where do I save my emergency fund?
Where should you keep your emergency fund? It needs to be easily accessible so you can take money out during a time of need. However, this could make it tempting to pull the money for non-emergencies, so finding a balance between accessibility and convenience is essential.
You have a couple of options when it comes to choosing an account:
A money market account could be a good option as they tend to have higher interest rates than a typical savings/checking account. Some of the banks that offer these accounts give a debit card or check-writing abilities, making the funds quickly accessible when needed. However, this also makes them easily accessible in non-emergencies if you’re not careful.
Another option is a high yield savings account, which also offers higher interest rates than an average savings/checking account. These can be set up with an online bank, which makes it a good option for those who will be tempted to spend the funds if you had a debit card attached to the account. On the other hand, with the account being online there could be a delay in receiving the funds. It is important to consider your self-control when choosing which account is best for you. Some high yield savings accounts also might limit the number of withdrawals you can make each month, so if you have an unusually bad string of luck one month you may not be able to access the funds (or pay a penalty to do so).
An option that requires little self-control is a certificate of deposit. These require you to keep your money in the account for a minimum time period, including an early withdrawal penalty. This option is ideal if you believe you will have the tendency to spend the money for a non-emergency, however, if you encounter an actual emergency before this time you’d have to cash out the CD and pay a penalty. For this reason, you should only use a certificate of deposit as an emergency fund source if you have sufficient savings elsewhere, such as a money market or high yield savings account.
Who needs an emergency fund?
Everyone should have an emergency fund or be working towards accumulating one. A recent survey from Vanguard found 26% of people had unpaid medical bills, 22% overdrew on their checking account, and 14% took a loan from their retirement account. These statistics explain why it is so important to start funding for emergencies. Most financial experts recommend saving enough to last 3-6 months without work. To calculate an estimate add up your monthly expenses, including only the bare minimum: rent, food, health insurance (etc.). And remember the purpose is for covering unexpected expenses, not routine expenses that need to be considered in your budget.
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