Life happens, and when it does your piggy bank will offer you little solace. In times of financial upheaval, which can occur at any time, you’ll need more than a penny or two for your thoughts. You’ll need security, a plan b, some kind of safety net…
What you need is an emergency fund: a pool of quickly accessible funds that will get you through emergency or short-term crises. Most superheroes have one, as does every super saver.
How much do you need (right now)?
The rule of thumb is: three to six months' worth of living expenses. The reality is: it depends on your situation.
Financial circumstances can change on a dime, be it a new child, an ailing parent, new house. The best way to weather these variables is not to roll with the punches. And please don’t duck and cower.
Your best bet for being prepared for your worst-case scenario is to:
- Build a three-to-six month cash reserve
- Review it annually to make sure that it still fits your current needs
Great advice. But where’s the money coming from?
Your savings, which you can buffer by:
- Saving more aggressively
- Slashing your discretionary spending
- Tapping into current or liquid assets (those that are cash or are convertible to cash quick, like short-term CDs)
- Funding via earnings from other investments (e.g.,stocks, bonds, or mutual funds)
- Considering other resources such as a cash value insurance policy you can borrow from in the event of a crisis
Fabulous. Now where do I keep all this extra cash?
First of all, there’s no such thing as extra cash. Basically, your money has three objectives:
- To pay for expenses
- To save for goals
- To pay back debt
Your emergency fund is a goal that can also serve purposes #1 and #3, should your worst-case scenario happen to you. In the meantime, don’t leave your cash reserve on its own to twiddle its nickels. It can earn its keep if you:
- Tuck some away in an FDIC-insured, low-interest savings account
- Stagger a little bit more in money markets and short-term, fixed-rate CDs*
- Invest cautiously in a money market mutual fund**
*Fixed-term investment vehicles like CDs will hit you with a significant penalty for early withdrawals. In other words, don’t put your entire safety net in one basket.
**You’re taking a risk on this one. A money market mutual fund is different from a money market deposit account in that it is not insured or guaranteed by the FDIC. While funds seek to preserve each investment dollar, this type of investment is subject to loss.
No matter the investment choice, be aware of any fees related to early-termination or early-liquidation. The loss of interest to liquidate a CD early is never fun, but it may be better than a high-rate payday loan (or two) to cover a short period of time before the CD matures.