You know that an essential part of your financial health is having an emergency fund of some sort. Creating an emergency savings plan to help you through difficult times is important. Your emergency fund can help you make housing payments, buy food and pay for utilities. If you want true financial freedom, you have to have an emergency fund. Before you set up your emergency fund, though, consider the following:
Stop Worrying So Much About Growth
First of all, it is important to understand the purpose of an emergency fund. Your emergency savings are designated for use in a true emergency. While it would be nice to be earning higher returns on that money, the purpose of an emergency fund is not to provide you with income, nor is it meant to help you build a nest egg. Once you build an emergency fund to the point where it meets your goal of covering three, six, nine, 12, or 18 months worth of expenses, you just let it sit. It’s a safety net.
Your emergency fund should be in a safe place. The whole point is that you have a reserve that can be called upon. Sticking your emergency savings in stocks — and watching the losses pile up when you might need that money — doesn’t really fulfill the purpose. Safe places for an emergency fund include savings accounts and CDs that are in FDIC-insured accounts. You can also consider Ginnie Mae funds that are backed by the U.S. government. The problem with Ginnie Mae funds for an emergency, though, is that if your emergency happens when the fund is down, you might have to take a loss. Plus, you will have to pay fees on any sort of fund that you use for emergency savings. Safety means that you will get a smaller return. However, you can shop around within those safe options for higher yields.
You have to make sure that your emergency fund is accessible. You want to be able get the money when you need it. This means checking the withdrawal rules for any savings account you put money into, since many have limits on the number of withdrawals you can take each month (usually three or six withdrawals per month). CDs can be helpful, and they usually offer higher returns that savings accounts, but accessibility can be a problem. You might want to set up a ladder for a portion of your emergency savings so that money becomes available, penalty-free, at predictable and usable intervals. One nice thing about Ginnie Mae funds for emergencies is that some funds offer check writing and other withdrawal privileges so that your money is accessible.
Another consideration with accessibility is how you get to your money. The nice thing about a savings account is that you can usually use an ATM card to get the money if you need it, or effect a quick and painless transfer to your checking account. Other types of emergency funds might require a few more hoops to jump through, limiting how quickly you can get the money you need.
You can, of course, spread your emergency savings around so that you keep some of it in a high accessible savings account, able to hold you over until you can access a CD or some other less immediately accessible source.
Peace of Mind
In the end, your emergency fund is all about peace of mind. You want to feel confident that you can take of things should some sort of financial hardship come up. In order to have the peace of mind, you need to make sure that your emergency savings are in some kind of guaranteed account, and that you will be able to access it, with little to no penalty, when you need it.
Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.