A Plain English Guide to Emergency Funds.
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Emergencies happen, and they require money. Most people think of their credit card as their emergency fund, but you should need to have a financial crisis on top of an existing crisis. This is where emergency funds come in.
There are at least two emergency funds you’ll want to establish. The first and most important emergency fund will have enough money to cover all of your financial obligations for 6 months. 3 months is the minimum desired in this account, you want 6 months. No matter how tight your finances are right now, you have $25 a month to at least begin setting aside for an emergency. The purpose of this account is to be available in case you loose your employment. 3 months could be cutting it tight to find a new job, but 6 months gives you breathing room.
The second emergency fund should have a set $5,000 - $10,000. The purpose of this fund is the replacement of a credit card. If your car breaks down, if the pipes burst, or if you have an emergency trip to the Caribbean for mental health, the money is there and you won’t incur debt. Restock this account as quickly as you can, but it’s not as important as the first emergency fund.
You’re not looking for investment gains in you emergency account, you’re looking for liquidity. Emergency funds are often placed into a money market fund (most banks have one), a no load tax free mutual fund, a basic savings account, in cash in a safety deposit box, or in a safe at home. Though you want these funds liquid, it is a good idea, especially when you’ve got your emergency funds fully stocked, to adjust for inflation each year and add another 4% so your account maintains its spending power.
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