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After four years of deep recession with unemployment rates hovering just under 10 percent, far too many Americans have become accustomed to living paycheck to paycheck. The idea of setting something aside for an emergency, while attractive, seems all but impossible. The alternative, however, may be much worse. During the recession, consumers were concentrating on debt consolidation as much as possible, but without an emergency supply of money — usually six months’ worth — one crisis could wipe out years of financial progress.
How big should an emergency fund be?
Experts recommend enough money to maintain normal living expenses for three to six months. Factors to consider in planning just how much to set aside include:
- size of the family
- existing debt
- amount of insurance coverage present
- work situation of other household members
Obviously a single person will need to set aside less money than a family, and a single mother of three would need more than a family of four where one parent continues to work. There is no set answer on amount, but all financial advisors agree that an emergency fund is a must.
How can hard-pressed consumers set anything aside?
The initial goal is simply to establish the fund and to get in the habit of adding to it regularly. After that:
- One of the best ways to build an emergency fund is to bank the annual tax refund rather than spend it. Approximately three-quarters of all tax payers get, on average, $2913 back each year. Put that money in a savings account where it can sit and earn interest, and leave it alone.
- Let spare change accumulate by tossing it in a jar. Even the smallest deposits in an interest-earning savings account build up over the year. Saving spare change really involves rounding up the regular expenses and putting that little extra back for a rainy day.
- Track expenses and competitively work to lower what is spent each month, with the difference going into the emergency savings account. Many people find this method to become a game, especially if other members of the family are drawn in to “work the numbers.” This is also a great way to make children more cost conscious.
It’s important to remember that all aspects of expense tracking and saving are exercises in discipline. The more that “muscle” is exercised, the stronger it gets.
What’s the best vehicle for an emergency fund?
In the beginning a simple savings account is the best place to park an emergency fund. Normally there are no fees attached to such accounts and they are easily maintained. As the fund grows, however, it’s important to consider where the most interest will be earned. At the point, it’s time to investigate options like certificates of deposit. Avoid volatility at all costs, which means no investing in stocks.
Remember, too, that the whole point of having an emergency fund is liquidity. Don’t tie the money up so it cannot be accessed when it’s needed. In time, as the amount gets bigger, it will be possible to leave a percentage liquid while investing the rest in higher interest earning accounts. At that point, the money isn’t just an emergency fund, but can be earmarked for retirement or future projects.