I’m going to go ahead and make a bold statement here: everyone should have an emergency fund.
What do I mean by an emergency fund? I define an emergency fund as a zero interest, liquid asset that will get you through expensive, one-time events that are likely to occur. Usually, this means cold, hard cash.
The fact of the matter is that we live in an uncertain world, and we never know what may befall us in the future. We may lose our job and need to cover our expenses without a salary. We may need an emergency medical procedure that isn’t fully covered by insurance. A close family member may need a loan. Our best friend may need to be bailed out of jail. Depending on your situation, there are innumerable things that can happen, and it behooves us to have an emergency fund that we can draw on to avoid financial disaster.
There are several attributes that I use to describe an emergency fund, so let me break them down one-by-one.
Zero interest. This means your emergency fund SHOULD NOT be a credit card. Having a credit card that charges 14.99% interest if you don’t pay off the balance is a very expensive emergency fund, and will likely worsen your financial predicament. Zero interest means cash that you can draw on where you don’t have to pay any interest on the money. Even better, your emergency fund will be earning interest, as I do with my ING Direct Orange Savings Account.
Liquid. You must be able to draw upon your emergency fund as you need it. If you lose your job and need to buy groceries, trying to sell your rare coin collection will probably mean you go hungry. Again, this usually means cash, but could also include financial instruments like a CD ladder.
One-Time, Expensive, and Likely. I know, these are three attributes packed into one, but they’re all related in that they will determine the size of your emergency fund. For example, if we’re building an emergency fund to tide us over until we find a new job, we will need to know roughly 3 things:
- our bare-bone monthly expenses
- the median amount of time it takes professionals in your industry and geographic area to find a new job
- how likely it is that lay-offs will occur at your company.
In a future blog post, I’ll use two hypothetical situations to show you how to calculate the size of your emergency fund. For now, I just want to introduce you to the 3 things you need to consider when building one.
Do you have an emergency fund? If so, is it zero interest, liquid and enough to cover one-time, expensive and likely events? Please share in the comments below!
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