Why Keep Emergency Cash?
By keeping an emergency cash fund, you protect yourself from lifes unknowns. Youve got a safety net just in case something expensive happens. You might lose your job, incur medical expenses, or have other accounts frozen in error. If any of these things should happen, youd need money fast. Your emergency cash is there for you.
If you dont have emergency cash, life can be difficult. You might have to borrow money at unfavorable terms. Then, youd have a debt burden in addition to the original problem. In addition, youll have flexibility, the ability to fix things quickly, and more choices if youve got cash on hand.
Appropriate Places for Emergency Cash
Emergency cash needs to be liquid. This means that its easily accessible without cost, delay, risk, or penalty. The best places for emergency cash are savings accounts and money markets. A ladder of short term CDs might also work, but youd end up paying penalties if you have to cash out early.
If you cant think of a good place to keep your emergency cash, look into internet bank accounts. You can get your money from these accounts in a few business days, and some even offer checkbooks and/or debit cards so that you can make a payment instantly.
Too Much Emergency Cash is Costly
Liquidity comes at a cost. The easier it is to get your money, the less you earn on it. As a result, you need to manage your emergency cash. Keep enough on hand but not too much. If your emergency cash fund grows too big, move some of that money elsewhere.
How Much Emergency Cash Should You Stash?
Look at your expenses to figure out how much your emergency fund should have in it. Youll want to have between three and nine months living expenses available. The level depends on how secure you feel. If you feel very secure (like you wont lose your job anytime soon, you have great insurance coverage, and you have good luck in general), then you may opt to just keep three months worth of expenses on hand.
If saving several months worth of expenses is not a possibility for you, consider an emergency cash fund of $1000 or so just in case.
Which Expenses Should Emergency Cash Cover?
If you look at your monthly budget, you probably have a wide variety of expenses. The important ones for your emergency cash fund are your basic fixed expenses: mortgage, rent, insurance premiums, transportation, food, etc. You dont need to include the amount you save for your future each month since you probably wont save in an emergency anyway (youll have bigger fish to fry if you lose your job or suddenly face huge medical expenses). Just keep enough stashed away to provide for your basic needs.
You can find a thorough list of various experts recommendations on the exact amount of your emergency fund at the getrichslowly blog. The author there dug into several books and summarizes the information nicely.
After You Spend It
After you use your emergency cash, youll need to rebuild the emergency fund as quickly as possible. Remember how nice it was to have some funds on hand, and start on the task of rebuilding those funds. You never know when the next crisis will come up.
Remember, no cheating dont use the emergency cash for non-emergencies (like TVs, home improvements, or vacations). You should have separate savings account for those other goals.