Frequently asked questions about emergency funds
What is an emergency fund?
An emergency fund is a source of liquid assets that can be tapped to make ends meet if you encounter a financial emergency. Everyone should have an emergency fund at all times. Don't touch the money unless you lose your job, become unable to work, or encounter an unexpectedly large expense (such as a big medical bill). Make sure the money is kept in an account that you could easily access without penalty and without subjecting it to investment risk (loss of principal) if a time comes when you need the cash quickly.
How much money should I keep in my emergency fund?
At one time or another, nearly everyone runs into a financial emergency such as the loss of a job or an unexpectedly large bill. That's why it's important to have an emergency fund, which is invested in something that can quickly and easily be turned into cash to make ends meet if the unexpected actually happens. As a rule, financial experts say you should have an emergency fund that's large enough to meet at least three months of your living expenses. Six months is even better. You might be able to get away with the minimal three months worth of savings if you also have a home-equity line of credit, built-up cash value in a life insurance policy or other source of cash that you could use to meet expenses for an additional three months.
How can I invest my money but keep it available for an emergency?
If you want to invest yet have access to your funds in case of an emergency, stick to investments that are highly "liquid" -- in other words, investments that can quickly be converted into cash with little or no loss in value. Checking accounts, savings accounts and money market deposit accounts are examples of liquid investments, but their rates of return are relatively low. Mutual fund shares, common stocks, and bonds that are traded on major stock exchanges have higher rates of return and are also easy to sell if you suddenly need cash. However, you may have to wait a few days to actually get the money, especially if a check must be issued and then sent through the mail. And you might be in for more of a negative surprise, depending on market conditions and its effect on the value of your stocks and bonds.
What should I do to prepare for household emergencies?
If you're a homeowner, sooner or later you're going to be faced with some sort of household emergency. Taking a few simple steps now could prevent a relatively small future emergency from mushrooming into a big one. Creating a household emergency fund is a first step. Set aside sufficient easily accessible money to pay for the next home emergency -- a new hot water heater, burst pipes, and the like. Save receipts from major purchases. Chances are you're going to need them. Set up a file where you can keep these important receipts. The best place is away from your home -- in your office, perhaps, so that if disaster strikes, you'll be able to show the insurance company what you owned and how much you paid for it. Also inventory all your household possessions. A detailed inventory (accompanied by photographs or even a videotape) is perhaps the best way to ensure a fair settlement from your insurance company if you must eventually file a claim.