There are so many great articles on PF blogs about emergency funds, and I can’t stress enough the need to have one. But how exactly do you go about creating one? Is it just a savings account that’s off-limits, or do you set up an entirely new account in addition to your savings and checking accounts?
Investopedia‘s definition of an emergency fund:
An account that is used to set aside funds to be used in an emergency, such as the loss of a job, an illness or a major expense. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to use high interest debt, such as credit cards, as a last resort.
We have a savings account that we only touch in times of emergencies. It’s a simple bank account, separate from our retirement savings accounts (which are also hands-off until that blessed day we say “adios” to our jobs… you know, when we’re 80). So that savings account is our emergency fund. We make deposits when we can, and do not take any money out of it unless we have to.
We’ve been lucky enough to never have had a true emergency, but we have used money from the account for large purchases, such as for our upstairs carpeting job. I only had to “borrow” a bit from it when I was on my six-month maternity leave, which I repaid as soon as I could when the paychecks started coming in again.
But I’ve always replenished it, and it’s continued to grow. Worst-case scenario, there’s enough to cover about 8 months of expenses — mortgage, bills, car insurance — if we ever find ourselves without jobs or in dire financial straits.
J.D. Roth of Get Rich Slowly has this take on emergency funds:
I think it’s wise to keep your emergency money someplace that’s not too easy to access. (Ignore this piece of advice if you know you’re disciplined enough not to use the money for other purposes.) You might, for example, open an account at a bank across town. Or deposit the money with an internet bank. Don’t carry a card tied to the account. You’ll still have access to the cash when you need it, but you will be forced to consider your actions before making a withdrawal.
When CDs were paying 4-5% interest, I had some of our money in those. But now, I could only get 2% interest — if I tie it up for 5 years. Thanks, but no thanks.
So we’re happy with using our savings account as an emergency fund. I don’t know how other people do it, but this method works for us. If you aren’t good at keeping your paws off your emergency fund, it might be better to look into putting it into a CD — that way, it’s harder for you to access it.