If you’re employed, you had better build an emergency fund. An emergency fund consists of anywhere from three to six months of expenses. Why? Because stuff happens. You could lose your job through no fault of your own. Or, your old car breaks down and the repair cost is significant. Then, you lose your job because you can’t get to work! An emergency fund gives you peace of mind when the unexpected happens. Without an emergency fund, you may have to resort to high cost types of debt, like credit cards or, worse yet, payday loans. An emergency fund helps you to avoid falling into the hamster wheel of debt.
If you haven’t figured out what you’re spending your money on, look at our post Where Did My Paycheck Go? Budgeting Basics. In any case, your emergency fund should be separate from the account you pay your regular bills out of. Why? Because keeping things separate provides piece of mind. You want to know where you are in the process of building up the emergency fund. You may want to consider one, or a mix, of the following options to park your emergency fund:
- Savings Account
- Money Market
- Certificates of Deposit
Each one comes with advantages and disadvantages. Savings accounts are separate from checking accounts and your bank should have online features that allow automatic transfers from checking to savings. That way, you set up automatic transfers once and forget about it. Money Market and Certificates of Deposit may have larger minimum deposit requirements but usually offer higher interest rates than a savings account. Also, Certificates of Deposit may have penalties for early withdrawals because the bank promises to pay you a certain interest rate for a specified length of time. If you retrieve your money out before the specified period, you are breaking the agreement and there is likely a cost to that. While building your emergency fund, you may want to start out with a savings account as a stepping stone to an account that pays you more to park your money but is also easy to access should an emergency arise. Once your savings account has enough money in it, you can roll over your funds into a higher interest earning instrument like a money market or a CD.