How to Build and Use an Emergency Fund

We all have large scale emergencies or other unexpected events that come into our life.

What would you do if you lost your job? How would you eat and pay the rent until you were able to get another job? What if your car broke down and required expensive repairs? What if your refrigerator, stove, or central heating or air conditioning unit broke down? What if you run a home business and your computer just up and died? In any of these situations you would essentially be forced to drop a lot of money very fast.

An emergency fund is there to help you cope with these events. Basically, an emergency fund is nothing more than a large amount of readily accessible cash that you can draw upon if and only if there is an emergency.

How much cash? Most financial planning gurus recommend that you have between 3 and 9 months worth of living expenses as your emergency fund.

How much do you have? Not enough? Just right? Too much?

Strategies for building an emergency fund

Even if you don't have any money in an emergency fund that doesn't mean that you can't build one.

Begin by consulting your budget to determine what 3, 6 and 9 months worth of living expenses would be and write those numbers down. Those are your savings goals. If those seem intimidating, don't let it get you down. Start with a smaller savings goal like $500 or $1000.

After you have your savings goal, budget regular payments into your emergency fund until you have met your goal. You can also reach your goal faster if you toss in windfall money such as tax returns and gifts. Yeah, I know, throwing your gift money into an emergency fund isn't that thrilling, but in the long run you will benefit.

When to tap into your emergency fund

You only tap your emergency fund if it is a true emergency.

Let me repeat. You only tap your emergency fund if it is a true emergency.

Dead appliances, job loss and a smoking car constitute emergencies. Despite what you think, your desire to take a deluxe vacation to Disney Land or Acapulco do not constitute emergencies. Christmas presents for your kids are also not an emergency! Either is the iPhone!

Two ways to use your emergency fund to generate extra income

Now that you have 9 months worth of expenses stashed away in an emergency fund, you're probably feeling a bit dismayed that it is just sitting in your account doing nothing. But don't worry, here's two strategies for putting that money to work.

First off, get the money out of your checking account and intro a high yield savings account. Checkout Bankrate.com to see who has the highest interest rate around.

Second, consider setting up CD ladders. With CD ladders you can capitalized on the higher interest rates of CDs and work around the fact that CDs cause your money to locked away for the duration of the CD.

Some examples of CD ladders:
12 one-year CDs spaced one month apart.
6 one-month CDs spaced one month apart.

Personally, I recommend that you always keep at least 3 months worth of cash fully liquid. High yield accounts are okay for this money, but no CDs. Absolutely do not put it into risky investments such as stocks