One of the essentials of good investment planning is preparing for the future, whatever it may bring. Therefore, a vital component of a solid investment planning is an emergency fund.
An emergency fund is designed to cover a financial shortfall when an unexpected expense crops up. Your emergency fund can serve as a place to get the money you need when you find yourself short. Because it must be reliable, it needs to hold guaranteed investments. In other words, savings accounts are good for emergency funds, while stocks are bad.
An emergency fund, by nature, also needs to hold liquid or otherwise short-term, accessible investments. Ideally, you won’t need to use the money in your emergency fund, and you will maintain it for the long-term.
It is a good idea to divide emergency funds into two main categories:
Short-term emergency fund is your go-to place when you have an immediate emergency. It should be in an accessible account, which will probably bear little interest. The most important consideration is accessibility.
Long-term emergency fund allows you to save for large-scale emergencies, such as job loss or a major natural disaster like an earthquake or fire, and earn a slightly higher level of interest. Accessibility is still important here, but it’s okay to choose investments that take a few days to liquidate – as long as you have a short-term emergency fund to cover you in the interim.
What Makes for an Emergency?
In order to ensure that your emergency fund is there when you need it, you need to be able to identify a true emergency. A true emergency is a situation that requires some sort of immediate action, and that can affect your long-term well-being or impact the viability of an important asset (such as your home).
How Big Should Your Emergency Fund Be?
We recommend that your emergency fund should contain at least six months’ worth of expenses saved up.
Building Your Emergency Fund
one of the most discouraging aspects to building an emergency fund is the large amount of money you must contribute. The good news is that you don’t have to fund your emergency account all at once. You can build it up a little at a time. The most important thing is to get started and to remain consistent so that over time you can reach your emergency fund goal.
Final Word
Being prepared for unexpected, unforeseen event is necessary in today’s dynamic world. An emergency fund will come in handy for meeting unexpected setbacks and reduce your dependence on borrowing money, most likely at high interest rates.