Importance of an Emergency Fund
Well after having the issue with my car, I cannot stress how important it is to have an EF. I’m not sure if I ever commented on the EF before, but I’ll explain my views on it.
Characteristics of an Emergency Fund:
- Baby EF If you’re just starting out, like getting out of debt, have a starter emergency fund in place. It has been recommended that $1000 should be sufficient. If you have a family, it would be wise to double or triple that starting out.
- Full EF Maybe you don’t have debt or just completely paid off all your non-mortgage debt, time to save. A good emergency fund contains 3 to 6 months of expenses, not income.
- Emergency! Don’t rush to this money like it will make your problem go away. Sit on the issue at hand and see if you can get through it without having to resort to the money. If it won’t happen, at least you have this money sitting there for it. Christmas is NOT an emergency either, it comes every year in December people.
- Inve$tment? Too many people think they should take this money and invest it to make money on it. This money isn’t for investing, it’s insurance for when life happens. Don’t tie it up in a CD or bonds, a money market will do. Keep this cash liquid and accessible to access it when you need to. It will rain and you’re going to need an umbrella.
- Rebuilding Maybe avoiding the emergency situation was too much to handle, and you had to use it. Now that things are back on track, replace the funds that were used back into the EF. Avoiding this crucial step and leaving the EF underfunded could become a problem later.
There are a lot of cases where you might need this money. Covering the deductible on medical insurance, sudden job loss, mechanical breakdown (like a car?), death in the family, and the list goes on. As I stated before this money isn’t sitting there like a savings account you can go blow on Christmas or a vacation. You set the money to the side and forget about what else you could be doing with it. People just starting to get out of debt often skip this step. The reason it is there is to avoid having to borrow money in the event of an emergency. Why would you fix one problem by going into debt thus creating a new problem? The EF is there to avoid trepidation and ease the situation at hand. You know as they say: People who fail to plan, plan to fail.
Right now, I am working toward a fully funded 6 month emergency fund. I’m considering putting it in several 6 month CDs that mature at varying times. Then I would be able to earn a higher interest rate on money that I probably wouldn’t need until I spent all of the inital money (still stored in a savings account).
The problem with a CD is the penalty you would take to break into it if you had to. That doesn’t keep the money liquid, it’s stuck in the CD for 6 months since you figure you won’t need to use it. If you could plan your emergency like that, it’s not an emergency. As difficult as it may seem to keep 10-15 grand around for emergencies, the money should not be treated like an investment to make you money. Like insurance, we pay a premium in order to have the coverage it provides. You never know when you’ll need the money which is why it isn’t an investment.