Unforeseen things happen all the time in life. Some good, and some not as good. An emergency fund savings (we’ve also heard it called a rainy day fund) is for those times when something not as good happens where you need some extra money.
For the quick read below, you’ll learn:
- Why you need emergency funds in savings
- Where you may use emergency funds
- How much you should save (and where to save it)
Emergency funds are a critical piece of your personal financial program
Some examples of unexpected or unknown activities that your emergency funds could help with:
- Job loss — between 2009 and 2014 20% of the workforce was laid off during the last recession.
- Auto Accident — over the course of your lifetime, statistics show you’ll get into 4 auto accidents (you may / may not be at fault)
- Health Needs — broken bones, significant disease (eg cancer)
- Home Damage / Costs — you may not have insurance for damage caused, or your deductible is high. For example water pipe breaks, flood, earthquake.
- Parent / Relative Begins to Live With You — this could be because they need help with their care, they cannot afford to live alone, etc.
If that’s not enough …. from a recent study, many of the people surveyed have or recently have had the following financial challenges:
- Unpaid medical bills: 26%
- Overdrew checking account: 22%
- Loan taken from retirement account: 14%
- Mortgage payment late (at least once): 13%
- Bankrupcy filing: 3.5%
An Emergency Fund or rainy day fund helps you be prepared for these unexpected things. You know you need to save money for Retirement (401k, IRA, etc) … but you cannot access this money without a financial penalty. The emergency savings fund allows you to sock away enough money to get you through the rough patch.
How Much Money Should I Save in an Emergency Fund?
The rule of thumb is that you should have between 3 to 6 months of expenses in your savings for a “rainy day”. This fund should be a top priority unless you have high interest debt (>15%). In that case, you should create a smaller emergency fund (one or a few thousand dollars) until the high interest debt is paid down. Expenses are those that are required to live and keep your family going such as (not all inclusive as each person’s requirements are different):
- Utilities – natural gas, electricity, garbage, water, etc)
- Loans – car, credit, home equity, other
- Insurance – car, home owners, life, health, etc
- Food – to cook at home, not restaurants
- Internet / TV / home phone – you may not need TV
- Cell phone
Where Should I Put My Emergency Funds?
You want your emergency fund (aka rainy day funds) in a liquid account — meaning that you can get the money (cash) immediately when needed. So a CD, bonds or stock would not work. Our believe is that a high interest savings account is the best option because they have very high yields and are also typically FDIC insured. Most of these accounts provide a high interest rate compared to regular savings or a checking account.
We know there are many demands for your money. And none of us have unlimited funds. Retirement is always first priority, and should be closely followed by reducing debt, emergency fund growth, and finally saving for college.
Of course please consult your financial adviser for advise, as we cannot provide details meeting every situation.