Q. I’ve heard it’s a good idea to have emergency money set aside. How much should I have and where should I keep it?
You are certainly correct that it’s important to have some money set aside for life’s inevitable emergencies. It’s not a question of “if” an emergency will occur; it’s a matter of “when”.
My general recommendation is to set aside between three and six months of your essential monthly expenses. Essential expenses are things like your rent or mortgage payment, food, utilities, basic clothing, health care related expenses, and minimum payments on your loans. Non-essential expenses include eating out, taking vacations, entertainment, unnecessary clothing purchase or even saving for college and retirement. You can find some more detailed emergency fund information at this earlier blog post.
Certainly, a three to six month range is rather large. Depending on your free cash-flow each month, it can take quite some time to build such a large stash of cash. How do you decide which end of the range is appropriate for you? Look at your income situation to decide. For example, if you are a dual-income family, with secure jobs in stable industries, you are probably safe with an emergency fund closer to three months. However, if your family has only one income stream or if your profession has limited job opportunities, I’d recommend something closer to six months.
Finally, where do you keep your emergency money? I recommend an FDIC-insured bank account, either locally or via an on-line bank. Link the new account to your checking account so you can access it quickly and easily. Your emergency fund should not be kept in your checking account as it would be too easy to spend! It should not be invested in something that could drop in value. Instead, view these funds as “insurance” not an investment.
John is a CPA and personal finance coach. Email your questions to email@example.com.
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