You must know what, why and how of an emergency fund. You definitely need to have that liquid cash readily accessible for you needs like a sudden health issue or loss of a job or even unexpected expenses. That liquid cash is something that you will need to consciously build before you start putting money into some of the best investments that you have planned for the retirement.
Size of the fund and the peace of mind
The size of the emergency fund is something that you will need to define for yourself. Typically this fund should be equal to 3 to 6 months of income however, I do not think that is a fair calculation. The emergency fund should be based on some hard cold facts, like your monthly expenses. That you will be able to arrive at only if you have a budget and you know how much goes out each month.
If you are not budgeting, I would suggest that you start doing it right away else there is no way you will build an accurate corpus of an emergency fund and I am sure that there is no way for you to know that you are over spending or under spending.
Tools for Budgeting
There are templates for budgeting, you can use SB’s Budget Template. Basic budgeting can be done even on a simple spreadsheet and realistically speaking that is all you need.
However with new technology comes new solutions and there are a number of personal finance apps that you can now download and do the budgeting stuff on a breeze.
Once you have that figure of the average monthly expenses, I suggest that you make sure that you understand why do you need an emergency fund.
One of the need could be a loss of a job. Will you be able to find a new job in six months or at least you will be able to create a new income stream in six months? If yes then go for six months emergency fund, else go for a higher emergency fund.
Emergency fund – Don’t stash it under the mattress
An emergency fund should be liquid and easily accessible while being safe. Cash stashed at your home is not a good idea for an emergency fund. Interest paying checking accounts or saving accounts can be a very good idea to keep money safe while earning interest on the money.
CD’s can be a good idea too, but keep in mind having an emergency fund in CD has its disadvantages as you will not be able to withdraw money without paying the penalty before the term ends.
However, I like savings accounts better as you can just get to the ATM and withdraw the money when an emergency situation arrives. Be careful not to incur any ATM Fees, so choose your bank carefully.
Peace of Mind
The size, the place is about how comfortable you are. If you think that you are comfortable with six months then so be it. It is all about having that peaceful sleep at night knowing that if tomorrow something happens then you have the money to tide it over.
Readers, do you have your emergency fund created and kept in a separate account? If yes, how much is its size in terms of monthly salary?