Not long ago, a general rule held that you should set aside enough money in an emergency fund to pay for three to six months of living expenses.
But the economic downturn and continued high levels of unemployment means that most jobs are more vulnerable and harder to replace. Given the new realities, I recommend people set aside at least six months worth of living expenses and build that up to nine months when possible.
An emergency fund exists to pay bills as usual until you can get back to work. Life is going to surprise us from time to time with things like car repairs and plumbing problems. When the unexpected happens, you don’t want to go into debt to solve a short-term problem.
Many people tell me it’s all they can do to keep their expenses in line with their income and they don’t have anything left to create an emergency fund. But everyone can – and should – create savings for emergencies, no matter their income level.
It’s important to set a goal and decide on a system to move methodically toward it. Someone starting at zero might set a goal of at least $500 or $1,000 and find a recurring expense to cut to begin funding an emergency account.
With $1,000 you have enough money to cover most short-term emergencies and you can begin saving toward your longer-term goals.
The operative word in the phrase “emergency fund” is emergency. You know how likely it is you are to succumb to temptation and tap your emergency fund for a non-emergency, like a weekend in Las Vegas with friends.
Some people set up separate accounts for emergency funds, even one at a less convenient bank or credit union than where they keep their checking account. Another way to make it harder to access an emergency fund is to avoid getting an ATM card.
Still, be sure you can get to the money within a couple of days. That means you won’t be paid as much interest as you would with a longer commitment, but that’s OK.
The size of your emergency savings fund will guide you to the appropriate type of account. For savings of $500 to $1,000, a regular savings account will be fine. A larger amount, say $10,000 to $20,000, you might put into a money market account. Avoid certificates of deposit, which you won’t be able to turn into cash until the maturity date.
For most people just starting out, finding the money to save for an emergency fund is a challenge. But once it’s there, it will help you avoid going into debt, save you stress and protect your credit.