The Importance of an Emergency Savings Fund

It has been said that there is no softer pillow than money in the bank. If you don't have any money in the bank then you probably can appreciate this statement. Many lie awake during sleepless nights wondering if their bank balance will stay positive until that next payday. It is an unfortunate statistic in a country with such growth and prosperity that last year's savings rate was negative, meaning people actually spent more than they earned. Everyone should have an emergency fund put away for rainy days, because it is going to rain whether you are prepared for it or not.

How Much Should One Save
Many experts agree families should save 3-6 months of expenses in their emergency fund. I tend to lean towards the lengthier side of that estimate, particularly in families with only one income, or only one parent. Single income households are at more financial risk to job loss, or a disabling injury or illness, because their entire income is being generated by one member of the family. At least in two-income households things could be scaled back and the family could survive on one income in an emergency. Notice this amount is 3-6 months of expenses, not income. If things get tight you could live without any of your disposable income and just pay expenses.

Where to Park an Emergency Fund
We aren't exactly trying to beat Warren Buffet here. Remember, the purpose of an emergency fund is to provide a low-risk parking place for your money that is easily accessible. This rules out things like mutual funds, single stock investments and CDs. The money could be retrieved from all three, however significant penalties may apply. In the case of stock funds or single stocks your emergency will undoubtedly occur at the lowest price for your stock(s) and you will lose a significant portion of your investment. I recommend keeping your emergency fund in a money market account at a local bank or credit union. Online savings accounts with institutions such as ING Direct or HSBC are not bad either, assuming your account offers a way to immediately access your funds (ATM card, checks, etc.).

For most families, $10,000 represents a healthy emergency fund amount. Imagine how much easier you could handle a job loss or a leaky roof with $10,000 in the bank specifically for that purpose. Deciding you need an emergency fund in the easy part; actually saving for one is what takes loads of discipline.