One of the most basic building blocks of any financial plan is the emergency fund. Every family should have one. An emergency fund is designed to protect you when a major setback occurs in your financial life. Things like a job loss, a medical crisis, or even a death.
The first rule of an emergency fund is that it should be put somewhere safe; under the mattress won’t do! It also should be liquid, or readily accessible. Bank checking accounts, savings accounts, money market accounts, etc. are all good choices.
Resist the urge to put this fund somewhere where the return is slightly better but the money is more inaccessible. Will you earn more with a CD? Absolutely. Will you want to be concerned with cashing in CDs at the time of an emergency? Probably not. And long-term investment vehicles like stocks, stock mutual funds, and real estate are especially inappropriate for an emergency fund. This is money that is primarily a layer of protection, not where you’ll see your greatest investment returns.
So how much should you set aside? For the answer to that question we turn to the experts. Here are some popular personal finance gurus and what they recommend:
- Jean Chatzky, author, Money magazine editor, and Today Show contributor, recommends 3-6 months of living expenses.
- Dave Ramsey, author and radio talk show host, recommends a two-step approach: a $1000 starter emergency fund until all debt but the house is paid off and then a fully funded emergency fund of 3-6 months of expenses.
- Author Mary Hunt recommends at least 6 months of living expenses.
- Suze Orman, author and TV talk show host recommends eight months of living expenses.
- Author David Bach recommends a minimum of 3 months of expenses.
The consensus seems to be that 3-6 months of your living expenses set aside in an emergency fund is about right. Obviously the more precarious your job situation or other factors that could affect your finances, the more you’ll want to save.
The important thing is to have an emergency fund and contribute to it frequently until it’s at a level that lets you feel more secure.