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What Makes a Good Emergency Fund?

One of the cornerstones of a solid financial situation is an emergency fund. Prior to the financial crisis of 2008, experts recommended that you have at least three months’ worth of expenses in an emergency fund. Now, though, many recommend that six months’ expenses should be the minimum – and some even suggest that you save up nine months’ to 12 months’ expenses in order to weather financial difficulties for longer.

As you look for a place to put this money, it is important to consider your options. You want to put your money in a place where it is accessible when you need it. Here are some qualities that characterize a good emergency fund:

Accessibility and Liquidity

The most important characteristics of an emergency fund are accessibility and liquidity. Accessibility refers to how easily you can get your hands on the money, and liquidity indicates the ease with which your assets can be converted to ready cash. The account that you keep your emergency fund in should be accessible and liquid.

In many cases, this means that your emergency account should be a cash account. When you have stocks and bonds, you have to wait to convert the assets into cash. The same is true of hoarding valuables. You have to find buyers willing to pay you cash for jewelry, artwork and physical gold. An emergency fund that relies on these types of investments can slow you down due to the possible lack of liquidity. Cash, of course, is about as liquid as you can get. Keeping your emergency fund in a cash account can ensure that you don’t have liquidity problems when you need money fast.

Accessibility is another important issue. Even if you have cash, it isn’t much good if you can’t get to it without incurring huge penalties. Some online bank accounts can take three to four business days to transfer money into your checking account. If you need the money quickly, this accessibility issue can cause problems. CDs also present accessibility issues, since withdrawing the money early usually triggers hefty penalties. In order to reduce the impacts, you can set up a CD ladder so that you have money maturing regularly. However, it is still a wise idea to have a short term savings account that can tide you over until the next CD in your ladder matures.

If you want your emergency fund to be accessible, you can keep it in a local bank account. Money market accounts sometimes offer better yields than traditional savings accounts, and you can write a check or two from the account when you need to.

Another option is to make sure you have a checking account at the online bank where you have your high yield savings account. When you need money, an instant transfer can be used to put what you need in the checking account, where you can access it with a check or a debit card. Some online banks offer ATM cards with their savings accounts, so you can get to the money quickly at any ATM. Consider these issues as you set up your bank account.

FDIC or NCUA Insurance

Before you entrust the money in your emergency fund to any financial institution, you want to make sure that it will be safe. If a bank or credit union fails, you don’t want to lose everything. Make sure that you are dealing with a financial institution that is insured by the FDIC or NCUA. That way, you know you will get your money if the bank fails.

However, it can still be a good idea to check the health of your financial institution. If you have your money in a bank or credit union that is unhealthy, and could fail, you might find that access to your money is restricted for a time. If your financial institution fails just when you need to access your emergency fund, you might be out of luck for a few days – or even weeks. Double checking the health of your bank or credit union can ensure that your money is in a financial institution that is less likely to result in inconvenience when you need your money the most.

Interest Yield

Another factor to consider is the interest yield. However, getting the best yield on savings account you plan to use for emergencies may not be as important as accessibility and liquidity. If you can get 1.35% on an account, but you won’t be able to get the money for three or four days, it might be advisable to choose, instead, the account offering 1.15% with immediate access to your cash.

If you have a long term savings account, and a short term account, this can be a solution. You can keep the bulk of your emergency fund in the account with a higher yield, and then keep enough to last you a week or so in the short term fund. That way, you have immediate access to some of your emergency stash while you wait for the money from your larger store.

Things To Remember About Savings Accounts

As you plan your emergency savings, you need to consider the limitations that come with savings accounts. By rule of the Fed you cannot make more than six withdrawals a month from any savings account, and many financial institutions limit your withdrawals to three or four a month. This means that when you take money from your emergency fund, you need to make sure that you take a large enough amount that you aren’t coming back for more too often.

Watch out, too, for bank accounts that require minimum balances. While this can be a fine thing while you are building your emergency fund, or while it is sitting there waiting for a rainy day, once you start withdrawing money, the story can change. Be especially concerned about accounts that charge you a fee once you fall below the minimum. These fees won’t help you as you deal with a financial emergency. Look for an account without a minimum for your emergency fund.

Setting up an effective emergency fund requires planning and thought. Make sure you vet your choices so that you choose accounts that are most likely to benefit your situation.

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Previous Comments
  |     |   Comment #1
Guess we all know the conventional wisdom discussed here.  In addition:

1. HELOC can serve as an excellent emergency reserve.

2. Roth IRA is another hidden gem for emergency reserve.
  |     |   Comment #2
This post  just plain poor advice.  "The most important characteristics of an emergency fund are accessibility and liquidity." is simply not true.

Nobody needs "emergency money" that is instantly available within a day or two.  That is why the good Lord invented credit cards.

In a week's time, I can convert almost any of my assets into cash.  That includes stocks, bonds, US Savings Bonds, online savings accounts, and Roth IRA.

I like to keep a two-month cushion of "ordinary expenses" in a checkwriting account, to cover normal bills and credit card expenses.  I have a little cushion in case of an unusual expense, or if my paycheck direct deposit ****s up, or if I lose my job.  For really severe unexpected expenses, I'll use a credit card.  And I'll have at least a month's time to tap my rainy-day funds as needed.

What's true is that you need a cushion somewhere.  When deciding "where", super-instant liquidity and accessibility are not the most important characteristics.  A rainy-day fund should probably not be in stocks - but NOT because of liquidity concerns.  Heck, I can sell a stock and write a check on the proceeds within two days.  (As explained above, I'd never need to do that.)  Selling stocks for living expenses may be exactly the right thing to do during an up period in the market.  The real issue is volatility - you can't know that stocks will be "up" when you'd like them to be.

Ken, you run an excellent site when it comes to banking.  Allowing posts like this with poor financial planning advice, reflects badly on you.  Stick to your core mission.
  |     |   Comment #3
Several points to #2:

1. Credit card: if you can always have the 0% offer (without transactions fee) available, which I doubt.  I will never pay any fee/interest on my credit cards, even in desperate situations.

2. Stock, bonds, etc.: Those are supposed to be long-term investment, selling it under pressure does not seem prudent, at least in my case.

In this low-interest environment, emergency cash is a non-issue for most folks, since we all keep a large amount of money is Reward Checking, CD with little cash-out penalty, and savings.
  |     |   Comment #4
I mean "In this low-interest risky stock market environment, we all keep some money in high-yield reward checking, low-penalty CDs, and savings (instead of pulling all the money into the stock market)."

Emergency fund was popular during the high/crazy time for stock market, it is indeed over-rated and just common sense these days.
  |     |   Comment #5
Any funds kept in stock can disappear if sold jn emergency.So far my funds in RCA by switching to new accounts have fared better than short term low penalty CDs.
  |     |   Comment #6
I think this is good advice for everyone, and I think Melman is wrong in his hypercritical spam.
  |     |   Comment #7
Hypercritical spam?  Do you even know the definitions of either of those words?

Look, this article is just plain poor advice on several points.

1) Online bank accounts are criticized because it "can take three to four business days to transfer money into your checking account. If you need the money quickly, this accessibility issue can cause problems."  Nobody ever needs cash-in-hand that quickly. 

2) Describing a stock account as an account where "you have to wait to convert the assets into cash" is simply wrong.

The author seems convinced that you need rainy-day cash in a coffee can buried in the yard, or in a corner bank where you can grab in on a moment's notice.  The premise is wrong.

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