Establish an Emergency Fund
Editor’s note: This is the fifth in a series of “10 Tips to Help You Get on Track for Retirement” from the latest Fidelity newsletter.
Alright, now we’re into tangibly saving. An emergency fund is just that - for emergencies. It’s not a vacation fund, for Christmas presents, or a slush fund. It’s there in case the unexpected hits. And it always does. Is it a car accident, loss of employment, health problems, or something else? Who knows - that’s why it’s unexpected, but at some point everyone needs extra cash to get them through a problem. That’s what this fund is for.
How much should go in? I like the rule of thumb of 3-6 months worth of living expenses. I like to be on the safe side - my emergency fund target is 6 months of average expenses for the past year. I don’t assume any spending cutbacks even though I know we would make some.
How should it be saved? Well, the main point of this fund is that you can get to it immediately when the emergency strikes. I’d also recommend a savings vehicle that doesn’t have the risk of decreasing in value. This rules out stamp collections and stocks. A good money market fund is invaluable. As I’ve mentioned before, I recommend ING Direct. Until recently, about two thirds of the fund was in the money market - the rest in a 5-year CD ladder. Since I’ve over-planned the fund, I feel it’s safe to tie some of the money up. It’s reachable in a true (and very expensive) emergency with a penalty (one half of interest accrued). Just last week I moved about 40% of the fund out of the money market and into a 6-month CD to get the extra interest out of it.
I’m not convinced I’m doing the right thing by having emergency fund money tied up in CDs. I’m going to reevaluate that decision periodically. Where do you have your fund saved? Anything besides a money market or savings account? Any temptations to scratch out a little extra bit of interest?
The bigger challenge though is accumulating the fund in the first place. This needs to be a high-ranking priority. Paying off debt and getting the employer match on a 401(k) are higher, but not much else is, if anything. It is absolutely a priority above other saving, such as college or additional retirement.
Here are some useful articles about building an emergency fund:
[…] Bill from No BS Finance has written about establishing an emergency fund. This entry acts as a reminder to not put off the emergency fund. It also contains some mild questioning as to the right savings vehicle for the fund. As part of the book ‘Yes, You Can Still Retirement Comfortably!’ by Ben Stein and Phil Demuth, Jonathan estimates the retirement nest egg that we’ll need to retire. […]
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