In our last installment of Wealth Wisdom we talked about Budgeting. It’s important to start with your Budget because so many other parts of financial planning are based on your Budget. One of the foundations of a good financial plan is your Emergency Fund.
An Emergency Fund is designed to be there in the event an Emergency comes up. Think of having to replace a hot water heater, get new tires (or transmission) for your car, or helping tide you over in between jobs because of a job loss. A good Emergency is not designed to generate the best returns for you over time, its designed to be there when you need it and provide some stability. It’s also there so you don’t have to tap into your investment account, 401k or borrow on a credit card if something comes up. That’s why it doesn’t need to be earning a lot, its there so you don’t have to touch your investments at the WRONG time or set you back on your other goals.
My favorite place to keep an Emergency Fund is in a high yield savings account, preferable at a different bank or institution than your regular checking account. This is not a requirement, but I like it being separate from your regular operating account for day to day bills so your not tempted to tap into it for impulsive purchases.
So how much should you keep in an Emergency Fund? The financial planning textbook would say it needs to be somewhere between 3-6 months worth of your regular expenses (see I told you the Budget would come in handy). 3 months is if you have 2 income sources. Think a dual income household (two people working) or 1 person working and a second source of passive income. If you rely in just 1 income (1 person working) then it needs to be closer to 6 months because if something happens to that 1 income, you need more time to figure out how to replace or increase that income.
3-6 months is just a starting point. Some people have big fluctuations in their income (think commission sales person) and might need a little bit more. Some people might be saving for a new car, and that car money needs to be on top of the 3-6 months.
SO, I want you to see if your Emergency Fund is in good shape and passes the 3-6 month test. I ALSO want you to see what rate you are getting paid on that Emergency fund account. If it’s not at least 3.5%, it’s probably time you looked at moving that money somewhere else.
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.