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WIKI ANALYSIS
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This article is a part of Wikinvest's Personal Finance section and Guide to Investing. Please contribute or edit to improve it. |
In life you should expect the unexpected, and this is why you need an emergency fund. The best you can do is to prepare for emergencies that require access to additional money and having an emergency fund is the ideal solution.
Financial emergencies can come in the form of a job loss, significant medical expenses, home or auto repairs or something you’ve never dreamed of. The last thing you want to do is be forced to rely on credit cards or a loan which could simply compound the problem.
How Big Should Your Emergency Fund Be?
Most experts agree that you should keep between three and six months worth of your living expenses set aside in your emergency fund. Depending on your specific situation and whether or not you have children, carry substantial debt and types of insurance coverage will determine what amount is best for you.
The reason you want to have three to six months of expenses saved up is that the most common reason for the need of an emergency fund is due to a sudden loss of income. If you or your spouse loses a job you still have bills to pay and it may take a few months to find suitable new employment. It is best to plan for a worst-cast scenario so that the smaller emergencies such as replacing the hot water heater that just went out will be easily covered.
Where should you store your emergency fund?
You should be earning interest from your savings or you are losing value due to the effects of inflation, but this is not a priority for your emergency fund. Consider placing your emergency fund into a liquid money market account (MMA). Most of the time, MMAs will provide you with a special checkbook so you can have immediate access to your money in an emergency situation. It is not recommended to use your emergency fund to purchase certificates of deposits (CDs) or Treasury Bonds due to the lack of liquidity or early sale penalties. It is also not recommended that you use your emergency fund to purchase mutual funds, stocks, etc... Even though most are more liquid than CDs and Bonds, the risk and variations in the market are too great to entrust your emergency fund.
When setting up an emergency fund, you will want to open up a separate account so that the emergency fund money isn't mixed in with your regular spending money since mixing makes it much easier to spend the emergency fund money on nonemergency things.
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