Create a financial safety cushion
The question isn't whether you should have money set aside in case of an emergency. Sooner or later, you're going to be faced with financial obligations you didn't see coming
The real questions are: How much money should you have on hand, and where should you keep it?
How much is enough?
Many financial advisors tell people to keep six months' worth of expenses stashed away for emergencies. That might be a pretty good rule of thumb, but these days it might not be nearly enough.
Consider this: In April 2009, the Labor Department estimated that 3.7 million Americans had been out of work for more than six months. Half of all people unemployed that spring had been out of work for three months or more.
While unemployment benefits can help ease the pain of joblessness, they only last so long—and generally cover only a fraction of a family's typical expenses. So you might want to think about expanding your savings to a full year's worth of expenses, especially if your household budget doesn't include a lot of discretionary spending that could be trimmed on short notice.
Where should I keep it?
Gone are the days when folks kept their savings under the mattress. But the old-fashioned rationale still holds: You want your rainy-day fund to be easily accessible and safe.
For most people, the savings vehicle of choice is a money market fund or a bank account. Why? Because they make it easy to withdraw your money when you need it and historically have involved very little risk.
The flip side, of course, is that they've offered very little growth compared with riskier investments. But when it comes to your emergency savings, the name of the game is preservation, not expansion.
Haven't started? Don't panic
If you don't have a financial safety cushion yet, now's the time to create one. If you immediately start putting money aside from each paycheck, you may be surprised by how quickly your savings add up. The important thing is to start now—and don't stop until you've reached your target.
One last note: Don't fall into the trap of assuming you can just borrow money or rely on credit cards in an emergency. In the face of a financial crisis, the last thing you'll want to do is to take on a lot of high-interest debt.
- All investments are subject to risk.
- An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.