The Emergency Fund is Your Most Important Investment - in Yourself

It is important to have an emergency fund to compensate for or add to your income in the event of an unplanned event, because all unplanned events cost money! It is also important to know how much money you need to have saved for these unplanned financial events. It is normal to estimate a very low amount if you have not done the math. Most, when calculating how much they need in their emergency fund are very surprised at how much they should actually have saved.

This account, once you begin saving, is not your retirement account. Put your emergency fund in a relatively liquid, easily accessed account. Put your retirement in a 401k or IRA, which are not as easily accessed.

How Much Should I Save?

The amount your emergency fund is an amount of money that will enable your family to survive, almost unnoticeably, for three months to a year without any additional income. Many families today do not have ANY money saved for emergencies such as a loss of employment, major home or vehicle maintenance or unexpected medical expenses. A recent CareerBuilder.com survey revealed that 41-percent of employed people where living pay-day to pay-day with zero saved, not even for emergencies.

The financial planning industry recommends that you have a minimum of three to six months of income saved in an easily accessible account for emergencies. This really is a minimum. If you are single, with no dependents, you can probably get away with three to six months of expenses saved. If you do not have disability insurance through your employer, have dependents, or live on a single income, your emergency fund amount needs to be significantly higher.

The formula is simple. Calculate the amount you need in your emergency fund by adding-up your monthly expenses (not income). Your expenses are not equal to your income (hopefully). Your expenses include your housing (rent, mortgage), utilities, regular bills (cell phone, electricity), debt payments, insurance, groceries, gas etc. The sum of your monthly expenses is your multiplier to determine your emergency savings goal. You are calculating the amount of money you would need for a month to maintain your family's standard of living. If my total expenses for the month are $1700.00 and I want to have a ten month emergency fund, you need to have 10 months * $1700 or $17,000 saved, or a three month emergency fund you would save $5,100.

Where Do I Put It?

It is important to understand that your emergency fund is not your retirement account, nor is it you vacation fund or Christmas fund. It is your emergency fund, and it needs to be accessible (liquid). You have a couple of options with regards to how you store this money.

Regular savings or interest bearing checking accounts are the simplest and the most easily accessed. You bank will also have a money market account which will have a better interest rate and is also easily accessed, usually with a monthly transaction limit. Certificates of deposit (CD's), where not as liquid, may offer a better interest rate. There is a penalty for cashing them in early, so plan ahead. If you want to buy a 90-day CD, only use one-half of your six-month emergency fund, not letting all of the emergency fund get tied up. Although these types of investment vehicles are not the best for your retirement fund, they are the most liquid investments you can have and where you want your emergency fund.

Financial Responsibility

It may be difficult in the beginning to create and put savings into your emergency fund. However, good savings habits are your responsibility and nobody else is going to do it for you. With some planning you can save, even a small amount, every month until you meet your goal. If you choose not to have an emergency account, you will be forced to pay for these unexpected costs when there is an emergency anyway, a much more painful process. Inevitably increasing your debt to cover emergencies will set you back even further, financially. With some planning, you can begin a savings plan, no matter how humble it may be.