This weeks starts three part series on emergency funds called Save More Money. In this series I will be talking about every thing from setting it up, where to put it, and how to fill it up fast.
In today’s post I’ll give you some cutting edge tips that will help you set up your emergency fund so it will do everything you want it to and more. I will also be covering some of the pitfalls I’ve seen people fall into and how to stop them.
1. An Emergency Fund Will Give You Your Sanity Back
An emergency fund is your insurance policy against all those unexpected things that come up in life that were not really prepared for. For example if your water softener would suddenly go out.
Ouch! This is an expensive repair. This happened to me a month before Christmas once. A $1000 gone just like that.
If your living life paycheck to paycheck this can put you in a world of hurt fast. It’s also not so fun to go through life like this. So now that we know what one is, how do we use it?
Emergency funds are only used for the times we really need cash at a moments notice when we don’t have enough for an unexpected expense. This isn’t money that is used on a regular basis. Here a few reason I use an emergency fund.
- An emergency fund helps you sleep better at night. Losing sleep over financial issues can cause fatigue and effect other areas of your life such as work and family life.
- An emergency fund lets you take advantage of other opportunities. Sometimes there are things that you would like to do but you just can’t because one slip up and you’ll have nothing left. With a funded emergency plan you don’t have to pass those opportunities up.
- An emergency fund will pump up your net worth. Having cash to spare will go a long way in helping you get a loan. Lenders love when you have extra cash set aside.
2. Liquidity Is The Name Of The Game
Keeping your emergency fund liquid or in cash is very important. To pull it out with no tax penalties is very important. Some also believe in trying to get the highest interest rate around. While I agree extra interest is great but having the money there when you need it is even more important.
In my personal opinion I am willing to sacrifice a little interest on my emergency fund so I can gain quick access to it. This brings me to my next point.
3. Have Easy Access But Not To Easy.
What I mean here is don’t make your emergency fund your savings account, credit cards, or debit card. While these are great tools to take advantage of they don’t qualify as great emergency funds.
Having your fund setup in places that are to easy to access will in most cases aid in taking advantage of it. In these places it’s just to easy to withdrawal money from. I will be going through my favorite places to put emergency fund cash on Wednesdays post.
4. Other Places You Shouldn’t Setup An Emergency Fund.
Here are a few places you should never put an emergency fund.
- Mutual Funds. Putting money in mutual funds gives you the risk of losing money from your account even if the account is set up very conservatively don’t do it. Mutual funds don’t guarantee any interest or particular performance.
- Annuities. Annuities are meant as retirement vehicles. If you put it in a variable annuity you fall into the same problems as mutual funds and if you put it into a fixed annuity you may get a guaranteed interest rate but you will face another problem that annuities will cause. Annuities are known for having surrender penalties on them. In fact fixed annuities have longer surrender periods on them. What this means if you set your emergency fund up in an annuity you not only have to pay taxes after taking the money out but you have to pay a surrender penalty most times around 8% of your account value to pull out the money.
- IRAs/ Roth IRAs. Again these are meant as retirement accounts. Whether an IRA is set up in a mutual fund or an annuity this is not a good idea. Doing this means you will face certain tax issues such as 10% tax on withdrawals before age 59 and a half.
5. Contribute Regularly And Have The Right Amount Set Aside.
Having the right amount of money in your fund is very important. So how much should you have? I recommend a minimum 3 month worth of cash set aside, 6 months would be preferred though. The reason I say this is because the time it takes for the average person to find a new job is a little over 4 months now.
Figuring out how much you need in your fund is very easy. Ask yourself what you make right now? Is it enough? Do you need more? If you are comfortable on what you make right now in a month times that by the number of months you wish to be able to live off of your emergency fund.
For example if you make $3700 a month currently and you would like to have 6 months saved in your emergency fund then you would need roughly $22,000 set aside for emergencies.
Last, you want to pay yourself first. So contribute on a regular monthly basis to your emergency fund. If you don’t have much money there are accounts you can start and fund with as little as $25 a month. Doing this helps grow your fund even when you don’t have much money in it to start with.
Do You Have An Emergency Fund?
Read the next article in the series on Wednesday to see where the best place are to set up your emergency fund and also see if your current emergency fund is in the right place and if not where a better place for it might be.
This post was recently featured on The Carnival Of Personal Finance by Mighty Bargin Hunter.
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