When dealing with a new client the first thing I review might be a surprise. Is it there asset allocation? Not first. Is it the overall beta of the portfolio? Nope not that either. Well it must be the overall strength of their holdings, right? Strike three. Believe it or not, the first item I review is to make sure they have enough money in their emergency fund.
How Much is Enough for an Emergency Fund?
Typically, 3 to 6 months of expenses is the norm. But in a day an age where credit cards are rampant and the housing mess has hurt many families, I would recommend having at least 8 months worth of expenses. Some planners may even suggest up to 12 months. If you have a job that is sales oriented and commission driven, you should be more on the 12 month side. By having a cash reserve, you are protecting yourself of having to use high cost ways of borrowing i.e. credit cards, pay day loans, home equity loans or lines of credit.
Where do You Put Your Emergency Fund?
You want the money to be liquid. That is a necessity. Checking Accounts, high yield interest savings accounts, money market accounts, CD’s and short term bond funds make good places to park your money (Avoid Auction Rate Securities).
Liquidity refers to how quickly an asset can be converted into cash. Your house is not a liquid asset because it could take months to sell it. Stocks are somewhat more liquid than real estate, but you can lose money on stocks if you’re forced to sell at a time when the market for your stock is less than favorable. Even though interest on liquid investments may barely keep up with inflation, the lower risk is worth the lower return when you may need the money quickly.
Always Shop Interest Rates
Always make sure to shop around. Although it can be convenient to have all your money at one bank, some institutions may offer a considerable more. I have seen checking accounts pay as low as .25% when you could get a money market account paying more than 4%. It always pays to investigate. More interest earned equals more money in case of an emergency.
More to Save, Consider a CD Ladder
If you an adequate amount in your savings, you may consider doing a CD ladder as Patrick did from Cash Money Life. A CD ladder will potentially help earn a higher yield without having all your money tied up for a significant time period.
Other reads on emergency funds:
- Moolamony: 10 reasons to have an emergency fund
- Get Rich Slowly: Which Online Savings Accounts is Best?
- Frugal Dad: The Need for a Local Emergency Fund
- Free From Broke: Reader Help: Building a Cd Ladder