Life is full of unknowns. And, as most people discover sooner or later, many of those unknowns come with a price tag.
That beautiful spring snowstorm that sent your car to the repair shop suddenly turns into an ugly $4,000 bill. The casual Saturday game of pick-up basketball that ended with a twisted ankle becomes a very formal $1,200 bill from an out-of-network emergency room.
While you can’t predict life’s unexpected events—nor should you spend an inordinate amount of time worrying about things beyond your control—you can ease those unavoidable financial burdens with an emergency fund. Building healthy fitness and finance habits today can help you bounce back from setbacks that much faster. As the saying goes: Hope for the best, but prepare for the worst.
How much money should you put into an emergency fund?
If you’re young and single with fewer financial obligations, saving three months of salary may be enough. But as a general rule, putting aside enough money to cover four to six months of living expenses is wise. This gives you a cushion for unforeseen events like a sudden illness or injury resulting in time away from work and lost income. Even with health insurance, out-of-pocket medical expenses can add up. The New York Times reported that “22 percent of the time, patients who went to a hospital covered by their plan still received a bill from a doctor who was not in the insurance company’s network.” Citing research from The New England Journal of Medicine, the article points out that average bills cost more than $900, with a bill on the high end topping out at more than $19,000.
Significant home repairs can quickly add up into thousands of dollars. While it’s feasible to prepare and save for that basement home-theater remodel, the furnace conking out in the middle of January isn’t something you see coming. And home repairs of a critical nature typically can’t wait. Suppose hail and wind show up unannounced. Get out the checkbook. According to Home Advisor, the average cost of a new roof is $7,034.
Workplace downsizing and layoffs aren’t uncommon in today’s world. Whether you’re single without dependents or the primary breadwinner for a family of four, an unexpected layoff is stressful. Should you find yourself in this situation, an emergency fund provides a certain peace of mind. Having enough money in the bank to safely cover living expenses for those weeks or months without a paycheck allows you to focus your efforts on finding a new job.
Where do you put money for an emergency fund?
You’ll want this money accessible. So safely store it in a painted mason jar or tucked between pages 74 and 75 of a book no one would ever think to pull from the shelf. This, of course, is a joke. But you do want emergency fund dollars kept in a place you can access without significant penalty. According to FINRA (Financial Industry Regulatory Authority), the best place for an emergency fund is in a liquid account. Tapping a 401(k) or other retirement account to cover an unexpected cost comes with hefty price tag, so do whatever you can to avoid that scenario.
For a simple solution, set up a regular savings account at a bank or credit union and make automatic contributions so you don’t have to think about it. This provides some return on deposits while allowing for withdrawals without penalty. As interest rates tick upward you’ll see a little more return, but don’t count on major accrual with a basic savings account.
Certificates of Deposit
Depending on your circumstances, your emergency fund could be a significant bundle. So making those dollars work a little harder probably makes sense. Consider putting money into certificates of deposit (CDs) to earn a slightly higher interest rate. FINRA suggests establishing a series of CDs of similar value, with one maturing every six months or annually. Called laddering, “you can roll over the CDs as they mature…The loss of interest you face for taking money out early may motivate you to keep your fund intact. But in a real emergency, the interest you may lose is a small price to pay for having the money you need.”
U.S. Treasury Bills
Like CDs, U.S. Treasury bills typically pay more than a simple savings account. And, similar to CDs, they can be timed to mature on a regular schedule. Unlike CDs, they offer shorter terms at 4 weeks, 13 weeks, or 26 weeks. T-bills aren’t bank products, but they are backed by the federal government. What does that mean? You don’t risk losing principal if you hold them until maturity.
Money Market Mutual Funds
It’s important to note that money market mutual funds are different than other types of mutual funds. By law, money market mutual funds must invest in low-risk securities, such as government securities and certificates of deposits. According to FINRA, “Compared with other types of mutual funds, money market funds are highly liquid, low-risk securities. Unlike money market deposit accounts, money market funds are not federally insured. While they are intended to pay dividends that are comparable to prevailing short-term interest rates, they can lose value.”
When do you create an emergency fund?
An emergency fund should be part of any sound financial plan, but everyone’s situation is unique. It often makes sense to first save for retirement in tax-deferred accounts like an IRA where your money can grow without you owing taxes on that growth until after you start taking money out. Paying off high-interest debt and building an emergency fund may be more important if you don’t have any cash reserves yet. Start simple: Save one month’s worth of expenses – or even put aside $25 per paycheck.
With an emergency fund in place, you can worry less about life’s unexpected costs. That gives you more time to enjoy that beautiful spring snowstorm or perfect your jump shot—with proper footwear, of course.
Things to Consider:
• An emergency fund may alleviate the stress of unexpected, high-cost life events.
• Putting aside four to six months worth of living expenses is wise.
• A simple savings account is a good place to start. For better returns on liquid accounts, consider CDs, T-bills or money market mutual funds.
• If you don’t have an emergency fund, start today. Even redirecting a few bucks per paycheck can add up.