I’ve read a few articles about emergency funds recently that make me worry a bit. Seems Americans aren’t saving as much as they should and if they are it’s in all the wrong places.
In a recent Smart Money article (April 2012- Fatten Your Reserves) they cite a bankrate.com study that shows only 24% of Americans hold a 6 month emergency fund and 25% have no savings at all.
This article went on to state that Americans are using alternative methods instead of a traditional savings account like borrowing from 401K, home equity, and insurance. I disagree and believe going down this path will bring more financial disater in the end as these alternatives come with very high risks.
Emergency Funds: The Basics
An emergency fund’s purpose is to shield you from unexpected events and emergencies. There are some basics we must remember about Emergency Funds.
1. Keep it Liquid- No, not in water, but keep it easily accessible. Don’t tie up your emergency fund in hard assets like your home, CD’s, investments. If an emergency happens, you need that money now, not in a several days or weeks that include paperwork and red tape.
It is wise to keep your emergency fund in a high interest saving account or Money Market account with check writing privileges. (Find one now)
2. Use for Emergencies Only- What is an emergency? Paying $5,000 health insurance deductible from a accident, transmission going out, out of work for 3 months are all clearly emergencies. Protect this stash for real emergencies.
If don’t have an emergency fund, start your emergency fund today!
3. Sleep at Night- How big should your emergency fund be? Big enough for you and your spouse to sleep well at night. That might be 3 months for some and 12 months for others.
If you have layoffs looming or an irregular income, then a larger emergency fund should be considered.
4. Don’t Invest It- Again, keep your fund liquid. Why not invest your emergency fund? The Smart Money article suggests bond funds as an alternative to high interest savings account. This is terrible idea as bonds really are volatile and risky.
Bonds are risky, there I said it. When the record low interest rates begin increasing in the next few years, bonds will become even more risky. Risk is for investments, not rainy day funds.
When thinking about emergency funds, there is no need to take on more risk. Keep it simple and boring. You’ll be glad you did.
Do you have an emergency fund? Where do you keep it?
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