Most financial experts recommend that everyone should have some cash stashed away for a rainy day. Unfortunately most people do not think about such things until it’s too late and something has already happened where they need the money right away. Those of us who are wise and think ahead will put some money away for hard times but as many as 41% of Americans do not have any money at all saved for an emergency.  You never know what life throws at you and it is always better to be prepared then to be sorry.

Why do I need an emergency fund?

Having an emergency fund can really come to your rescue when unplanned expenses arise. You never know what can happen; the loss of a job, your car breaking down, your house burns down, unexpected medical expenses; virtually anything can happen and things usually happen at the worst possible time. But in every case, those with an emergency fund do better than those without.

In the absence of an emergency fund credit cards usually fill the void, leaving you burdened with high interest debt. This can cause further financial difficulties by increasing your monthly bills for quite some time into the future as you are paying down a high credit card balance, thereby straining your monthly budget even further. You need to have a solid plan on how to deal with unexpected expenses, and having an emergency fund should be a top priority.

How much should I save in my emergency fund?

The answer to this question really depends on your personal circumstances.  It will depend on your income level, size of your family, and the type of emergency that arises. The general recommendation is to keep between three and six months of living expenses in the fund. But everyone has a different comfort level and if you are a high income earner and are used to living a certain lifestyle you will obviously have to put a lot more money into your emergency fund.

Additionally if you are deep in debt, it does not make a lot of sense for you to keep a large chunk of cash stashed away that is earning you 3% interest and at the same time pay 8 to 15% or more in interest payments to credit card companies.  In a situation like this it is wisest to keep about one or two months of living expenses in your emergency fund and use the rest to pay down your debt. Once your debt is paid down start adding money to your emergency fund once more.

Where to keep the cash?

The ideal place to park your rainy day fund should pay a decent interest, be devoid of fees, be not too easy to access and at the same time not too difficult to get to your money in case you need it. Good places to park your emergency fund money would be a money market savings account or a CD.

My thoughts on this, is to keep a small amount of cash at home for minor emergencies. About $500 to $800 should suffice. Keep two to three months of expenses in an online savings account, this way it is available if you need it but at the same time a bit restricted; since you cannot withdraw it at your local branch. The remaining three to four months worth of living expenses should be kept in a CD since it will usually pay a higher interest rate then an online savings account.

If you put your emergency fund money somewhere the funds are not easily accessible, ensure that you have an instrument of equivalent value available for use; such as using a credit card at the time of the emergency and then repaying it in full as soon as you get your funds.

Step by step plan for putting together your emergency fund

1. If you currently have no money put away for emergencies, I would highly recommend that you immediately save $1,000 and put it in a high yield online savings account. This money would obviously not be enough to get you past any emergency, but it’s a good start. If you do not have a $1,000 start small. Open a rainy day savings account and put $50 in it. Slowly add money every month to this account, and before you know it you will have a emergency fund.
2. I would then advise for you to take a close look at your debt.  If you have debt, and most of us do, put together a debt elimination plan and begin to rid yourself of debt.  (More on this in the near future)
3. Once your debt has been mostly eliminated you should start adding more money to your emergency fund. Try to be disciplined by considering it a bill you have to pay and including it in your monthly budget.
4. Once you have saved up six months of expenses in your emergency fund you can start saving towards other goals or for investment purposes.

Mistakes to avoid

• Don’t confuse your 401K with your emergency fund. Many people think that they can use their 401K in case of emergencies. Do not make this mistake and do not touch your 401K until you are in your mid 60’s. If you do you are going to have to pay penalties and taxes.
• Do not keep your emergency fund money mixed in with other funds in the same account. Make sure that your emergency fund is kept separate from your other accounts.
• Do not use your emergency fund as your personal cash cow for buying more stuff. The only reason you should ever tap into your emergency fund is in an emergency situation.
• Do not let your emergency fund run out.  If an issue arises and you are unable to pay your bills for the month, take the money out of your emergency fund, that’s why it’s there, however make sure to replenish it over the next several months.

A fully funded emergency fund can keep you out of debt and make life easier during those high stress times when things don’t go your way.

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