Plan for the Unexpected with an Emergency Fund

Financial Industry Regulatory Authority (FINRA)
Plan for the Unexpected with an Emergency Fund
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Set aside enough money to cover your expenses for three to six months. ©iStockphoto.com/Spectral-Des …

A rainy day fund is one of the most essential building blocks of financial security.

Most experts agree that it's important to set aside enough money to cover your living expenses for three to six months in an account you use exclusively for emergencies. This money will give you a cushion to handle a short-term job loss, a surprise car repair or other financial emergency. Without savings, you might need to rely on credit cards and other borrowing at high interest rates to pay for unexpected expenses. This could put you into serious debt.

Smart Tip: Start small. If you started saving just $10 a week, by this time next year you will have a rainy day fund of over $500.

The best place for your emergency fund is in a liquid (easily accessible) account. A liquid account might be a regular savings account at a bank or credit union that earns some return on your deposit. It’s also an account that lets you withdraw funds at any time without a penalty.

To earn a slightly higher interest rate, some people choose a certificate of deposit, or CD, for their emergency fund, or a series of CDs of approximately equal value, with one maturing every six months or every year. This approach is called laddering. You can roll over the CDs as they mature, to keep your ladder intact. This gives you more liquidity and a more stable source of income in the fund.

The loss of interest you face if you take money out early may motivate you to keep your fund intact. But in a real emergency, that is a small price to pay to get the money you need.

You could also buy U.S. Treasury bills with some of your emergency fund money. They, too, can be timed to mature on a regular schedule. And like CDs, they tend to pay more interest than a simple savings account. While they aren't bank products, they are backed by the federal government. That means there is only a small risk of losing principal if you hold them to maturity. U.S. Treasury bills have very short terms—4 weeks, 13 weeks or 26 weeks.

Another place to park your emergency cash is in a money market deposit account at your bank, which is like a checking account that pays interest.

Bumps in the financial road are inevitable. An emergency fund can smooth the ride. And remember, if you have to spend any of that emergency money, plan to replace it.

For more information on how to invest wisely, visit FINRA.org/Investors.

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