An emergency fund is usually the first goal that everyone focuses on when they decide to take control of their finances. A recent study showed that over 50% of Americans wouldn’t be able to come up with $400 if they needed to. Most people just tend to spend what they have so there is never money left over at the end of the month. If they took $1 a day and put it in a jar, they would manage to save almost $400 in just over a year. So should you just grab a jar and start saving? Maybe…
Once you decide to set up your emergency fund, let’s figure out where you should keep it. Although a jar is better than nothing! There are many different options, but let’s first discuss the basics of an emergency fund. Generally, it should be 3-6 months of expenses. If you aren’t there yet financially, make it at least $1,000 to start. This money is for emergencies only. New shoes are not an emergency. A new TV is not an emergency. These are things you expect to replace. This money should be used for things such as medical emergencies, car accidents, or loss of a job. Non-emergency savings should be kept in a separate account.
Where should you keep your emergency fund? People get really frustrated about setting aside a pile of money in an account that earns virtually nothing. Unfortunately, this money needs to be accessible on the spot, so you don’t want it locked up in an investment that could go down in value. I could go through every investment type and give pros and cons for each, but I will focus on the best option. But first, don’t keep a pile of cash under your mattress. The last thing you want to do is try to convince your insurance company that someone stole $10,000 cash.
The best place for an emergency fund is a savings account with an online bank. Here’s why.
1) The money is FDIC insured. The government will refund you if it gets stolen.
2) These online banks pay around 1.0% on savings accounts. This is the best rate you can get right now for a risk-free investment.
3) Choose a bank that you don’t have your regular accounts with. This will keep you from seeing that extra money and being tempted to use it.
Emergency funds are crucial to financial success. Don’t let something like a job loss completely bankrupt you. If you haven’t set up an emergency fund yet, start by transferring $100 a month to a new account. You will be off to a great start as long as you pretend it doesn’t exist until an emergency. Just remember that the extra 30% off those boots is not an emergency!
Mike Zeiter, CPA/PFS