What Is an Emergency Fund?
An emergency fund is an amount of money that you set aside in case of unexpected costs, such as a medical emergency, loss of a job or major car repairs. Having an emergency fund offers both psychological and financial benefits, and using software like Quicken to help you plan your savings benefits both your stress levels and your bottom line.
Emergency Fund Size
The precise size of an emergency fund varies depending on who you ask. For example, in USA Today, financial adviser Wayne A. Lippert Jr. suggests having between nine and 12 months of living expenses in such a fund, while US News finance writer Aaron Crowe suggests having between six and 12 months stashed away for emergencies. When you run the numbers, it can seem daunting to try to reach those amounts, particularly if you don't have anything saved yet. So, it's a good idea to start with smaller goals and build from there.
Calculating Living Expenses
When deciding the target for your emergency fund, consider all of your living expenses and decide which ones you might be able to cut if push comes to shove. For example, if you lose your job, would you be able to go without eating out more than once a week or once a month to save money? If not, you need to save more in your emergency fund. On the flip side, if your current monthly expenses total $1,500 but you know you can cut out your $100 cable bill and $50 worth of coffee drinks, you can set your emergency fund at $1,350.
Benefits of an Emergency Fund
Having an emergency fund gives you peace of mind that even if an unexpected expense arises, you will be able to weather the financial storm without going into substantial debt. In addition, without an emergency fund, you could be stuck taking out a high-interest payday loan or carrying a balance on a high-interest credit card. If you can't make the payments on those loans, you could end up bankrupt.
Where to Keep Your Emergency Fund
Your emergency fund should be held in an account that can't lose money, such as a savings account at a bank. And, according to US News, you should keep it in a separate account from your regular spending money. Savings accounts, like other deposit accounts, are covered by the Federal Deposit Insurance Corporation, which protects the first $250,000 of your deposits at a bank in case the bank goes out of business. While it might be tempting to seek higher returns, such as by investing your emergency fund in the stock market, those investments could lose money, leaving you without a cushion if a financial emergency arises.