Life is full of surprises. Your car needs a new muffler, a hefty tax bill shows up in the mail, or your luggage disappears somehow during the flight to Hawaii.
But what do you do when one of these things happens?
Well, most financial experts recommend having an emergency fund to fall back on. But what exactly is an emergency fund? And what’s the best way to go about building one? And perhaps just importantly, what doesn’t qualify as an emergency fund?
It’s up to you to decide on the size of your emergency fund. The Simple Dollar‘s Trent Hamm wrote onfor the Christian Science Monitor that it should be roughly about two months worth of living expenses for each member of your household. If you figure it costs $2,000 to house, clothe, and feed each member of a 3-person household for two months, for example, then you should have $6,000 set a side. Hamm also notes that it’s more important to pay off debt before focusing on building your emergency fund. If you’re neglecting paying off all that high-interest date by setting aside cash, you’re not doing yourself any financial favors.
Kiplinger spoke to a financial analyst who recommends a money market or savings account for this type of fund. While the interest rates on these types of accounts aren’t the highest out there, but they give you flexibility and easy access to your funds. Ally Bank’s Money Market Account and Online Savings Accounts, for example, can be accessed at any ATM with your check card. And while the rates are lower than we offer on our CDs, they are still some of the highest out there in the marketplace.
On the entirely other side of the spectrum are those that believe that building an emergency fund shouldn’t be anywhere on your financial to-do list. Liz Pulliam Weston writes on the MSN finance blog that actual financial flexibility—not a stash of emergency cash—is the key through getting through those unexpected times when money is needed. She argues that a meaningful emergency fund takes too long to build, and there’s always the chance that you won’t need it. Instead she advocates the responsible use of credit cards and home equity lines of credit during these times and using extra money to make wise investments.
Many people think that if there’s ever an emergency, they’ll just use their credit cards, but interest payments just add insult to injury. And there’s always the possibility that the garage in the small town where your car broke down won’t take plastic. So in the strictest sense, available credit on your your credit card does not count as an emergency fund. Still, how you plan for unexpected expenses is up to you, but there’s no denying that it’s a plan you need to make.
How did you build your emergency fund? Do you use cash, credit, or a mix of both?