The following is a guest post. Enjoy!
Emergency Funds – Are They Essential?
When it comes to emergency funds, most people have strong opinions one way or the other about the value of this type of account. While some believe that this is the secret to peace of mind and stability, others believe it to be an unnecessary precaution. There are several different factors to take into consideration when it comes to deciding whether or not this is the right option for you.
What is the Purpose of an Emergency Fund?
When you have an emergency fund, the idea is to have money available in the case of the unexpected happening. This means that when an unexpected bill arrives, something happens and your car is totaled, or you get in a wreck and need surgery, you have the money necessary to take care of the problem. There is no reason to make a charge on a credit card, and there is no reason to borrow money from friends and family members. It gives you a sense of independence when problems arise.
Benefits of an Emergency Fund
When you already have the money that you need on hand, you don’t worry so much about what you will do when the unexpected happens. You know that you have the emergency fund, and you can take care of most of the problems that will come your way.
For some people, sleep will come a little easier at night when they can worry less. If you have your emergency fund in a general savings account, your money may be earning interest. While it probably isn’t going to be much, there is going to be some type of return on your “investment.”
Where to Invest Your Emergency Fund
Shop around to find the best place to set up this account. Read the terms and conditions carefully to find out if there are penalties for withdrawals and what the minimum balance needs to be.
On the downside, if you don’t invest the money, you aren’t really getting anything back. In an interest bearing account, the money will actually be working for you. You will see that the money you deposit is earning something and not just sitting somewhere waiting to be used in case of an emergency.
Cons of Having an Emergency Fund
If you use the cash from your emergency fund to pay for unexpected expenses, you are partly missing out on a chance to build your credit. A prepaid debit card or an actual credit card can also make it easy to take care of these emergencies, and on the upside, they are also helping your build positive credit when you make payments on time and pay off the balance.
Balancing the Pros and Cons of an Emergency Fund
Having an emergency fund is a personal decision that only you can make. There are several different options that you can choose from that will help you balance out the positive and negative aspects of an emergency fund.
Here are two options to consider:
- Keep half of your money in cash and the other half in a higher interest-earning account. This way, you have the money that you need and you are earning interest.
- As you continue to save, add the extra money to the interest bearing account.
- When a major expense arises, use your credit card to pay off the amount that you owe. Then, use your emergency fund cash to pay off the card. This way, you still have the cash so there is no need to worry and you are able to add to your personal credit score.
How about you all? Do you have an emergency fund? How many months worth of expenses do you target to have in the account? Do you feel an emergency fund is necessary?
Share your experiences by commenting below!
Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.
- @ Purpose of an emergency fund – First, I have to disclose that I am a big supporter and promoter of people having an emergency fund. I carry an emergency fund myself in which I target holding 6-9 months worth of my normal expenses. In fact, I place so much importance on having an emergency fund that in my account hierarchy, saving money for this type of fund is at the top of the list, right alongside having health insurance and paying off your credit card debt monthly minimums.
- Having gotten this disclosure out of the way, I’ve found that a lot of people get confused about the actual purpose of an emergency fund.
- An emergency fund, as the name suggests, is for unexpected serious expenses that are necessary for your normal income creation to occur.
- Examples of what would fall in to this category are unexpected car expenses, health care deductible bills, paying the $2,500 deductible on my condo insurance policy if my apartment burned down, buying a plane ticket to your relative’s funeral half way across the country, living expenses if you are downsized/fired from your company, etc.
- Examples of what would NOT fall in to the realm of what an emergency fund should be used for are $10,000 wedding rings, a new couch that you desperately need, a $5,000 surgery for your dog (unless you already have this savings factored in to your emergency fund amount), or a vacation to the Bahamas.
- How much money to place in your emergency fund – It seems like there are several opinions on how much money one should place in to your emergency fund. The general consensus seems to be to place anywhere from 3-9 months worth of expenses in this account. The logic behind these numbers is that this is generally the period of time needed for someone to find a new job, in the case that they are let go from their past job.
- Personally, as a fairly cautious person by nature, I tend to prefer staying on the high-end of this rule-of-thumb time frame (6-9 months of expenses).
- @ Where to place your emergency fund – In this day and age, there are of course a plethora of options for where you can place your emergency fund. I’ve discussed these different options at the following link – Bank Savings Options – My Personal Finance Journey. The options are listed briefly below:
- Bank savings account
- CD
- Money market mutual fund
- Money market saving account
- Of these 4 options, the one that I personally feel is the best to use (even though interest rates in the US are INCREDIBLY LOW!) is a money market savings account.
- By using a money market savings account, which generally has high interest, stability for your money, and good history in not defaulting, you don’t need to invest half your money in cash and half in a “high-interest-earning account” (as suggested above in the post) because your money will already be in a dependable, high-interest earning account.
- My favorite options for a money market savings account at this point in time are either ING Direct or DollarSavingsDirect.com.
- @ Cons of an emergency fund – Personally, I don’t really feel that there are any cons of having an emergency fund.
- The one con mentioned above about using an emergency fund to pay for unexpected expenses slowing a person’s credit accumulation down doesn’t, at least in my opinion, apply to today’s society since we are already making most of our purchases on a credit card anyway.
- @ Paying for the emergency expense via credit card and then reimbursing yourself with money from your emergency fund –
- This is a great idea! By paying for the emergency expense with a credit card (if possible), your purchase is protected against fraud, and you will also accumulate cash-back or other reward points, if offered by your credit card.
***Photo courtesy of http://farm4.static.flickr.com/3112/2346575422_7054222273.jpg
