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Emergencies, by their nature, are unpredictable. When they happen, they can derail your financial stability. A sudden illness or accident, unexpected job loss, or even a surprise home or car repair can devastate your family’s day-to-day cash flow if you aren’t prepared.
While emergencies can’t always be avoided, having emergency savings can take some of the financial sting out of dealing with these unexpected events.
An emergency fund is a separate savings or bank account used to cover or offset the expense of an unforeseen situation. It shouldn’t be considered a nest egg or calculated as part of a long-term savings plan for college tuition, a new car, or a vacation. Instead, this fund serves as a safety net, only to be tapped when financial crises occur.
While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months’ worth of expenses. This amount can seem daunting at first, but the idea is to put a small amount away each week or two to build up to that goal. You may also want to consider adjusting the amount based on your bill obligations, family needs, job stability, or other factors.
Emergency savings are best placed in an interest-earning bank account, such as a money market or interest-earning savings account, that can be accessed easily without taxes or penalties. The concern with placing your emergency savings in mutual funds, stocks or other assets is that they may lose value if the funds need to be accessed quickly.
The goal is to tap your emergency savings only for expenses directly related to an unexpected emergency. By setting a specific dollar amount that should be in that account, you will know how much to build up to; when you draw from the emergency savings, you’ll then know how much to contribute in order to replenish the account. And when you do have to take money from this fund, it’s important to immediately start rebuilding it. Remember: If you start saving now, the money you save today can go a long way towards meeting your needs when the next emergency occurs.