The Emergency Fund

I hit on the main ways of diagnosing your financial health in this past post.  I'm going to use Wednesdays to go further in depth on each point since I truly believe that financial health leads to less stress and happier lives.

I covered the first point, Spend Less Than You Earn, last week.  The second point was to have a solid emergency fund.  This means that you need liquid reserves in order to cover unexpected circumstances.  Job loss is the most frequently mentioned reason for emergency funds that I have read so far.

Start a Separate Account
I'd suggest starting a separate account for your emergency fund so you'll be less likely to use the money if it's away from your normal accounts.  We recently chose to keep our emergency money at Smarty Pig since they currently have a 2.01% interest rate while ING is only at 1.1%.  I sometimes forget about our emergency fund account for weeks at a time.  It usually only pops into my head to check on it when I'm updating our monthly net worth.

If you don't like the idea of a separate account, I've also seen recommendations for starting a CD ladder, investing in a money market account, or buying bonds.  I personally would try a CD ladder instead of one main account once you have a couple of months of expenses saved up and CD's are paying more than the Smarty Pig basic rate since you should get a higher return for tying up your money.

Set Up an Automatic Deposit into this New Account
We automate almost everything in our fiscal lives to reduce the probability of human error and to take some emotion out of financial decisions.  If you automatically contribute to this separate emergency fund account, you won't be able to "forget" and it will be less of a hassle.  Start small if this idea scares you.  Simply contributing $50 a month is a start.  Once you realize that you really aren't missing that $50, raise it to $100.  Before too long, you'll be happy with your contribution level and can put the thinking aside.

Choose a Target Amount
Now that you have started an account, you can sit down and figure out how much you are aiming for overall.  Almost everyone agrees that you will need at least 3 months of living expenses saved up to breath easy.  Most people also have raised that goal to 6 months to a year in these unstable economic times.  I personally suggest saving as much as you need to not worry. 

My husband and I only have 3-4 months of expenses set aside right now, but we are raising that to 6 months by the end of this year since that is the new average time that it takes to find a job if you are laid off from your old one.  Some of my readers suggest having 9 months to a full year set aside.  It's definitely a personal decision that needs to be based on your circumstances. 

How many incomes does your family live on?  How stable is your job?  How much would you be able to cut from your budget if you lost your job?  Do you have kids depending on you as well?  These questions can help you decide what you'd like to save for your peace of mind.

Save Consistently Until You Reach Your Goal
This part will come naturally if you are automatically contributing to your new account.  Your biggest worry once you hit your goal will hopefully be what to do with your monthly contribution after that.  Believe me, that would be a great problem to have.

What do you think?  Do you have an Emergency Fund?  What amount are you aiming for or already have set aside?