Your Emergency Fund is Like Insurance

Most of think of insurance as a necessary evil. You must have auto insurance. We all know that one health problem without insurance can cause financial ruin. Life insurance provides some peace of mind in case something should happen to a family’s primary income earner. But, many Americans (nearly 50%) have a different attitude when it comes to squirreling away rainy day money, a.k.a. an emergency fund.

What is an emergency account?

An emergency account is not your 401(k) or your IRA—those accounts should primarily be reserved for retirement savings. Borrowing from these accounts in cases of emergency could leave you with devastating penalties and loss of future income. And, it’s not your child’s college savings either.

A true emergency account is a liquid account that you can draw on anytime some out-of-the-ordinary financial event should occur—either without risk, or with little risk. Typically, emergency funds are established using a secondary savings, money market, CDs, I-bond accounts.

Secondary savings accounts offer easy access, but will pay the lowest interest. Money market accounts offer higher rates, deposits and easy, but limited access. Certificate of Deposit accounts usually penalize for early withdrawal, but the penalty is often equal to just one month’s worth of interest and is a small price to pay when you need money fast. However, CDs do not typically allow deposits after opening. Series I US Savings Bonds pay enough interest to keep up with the rate of inflation. This too has drawbacks, however. The most you can buy in one year is $10,000 per person. And, you can’t cash them in for at least one year after purchasing them.

How do you fund an emergency fund?

Typically, your monthly budget is distributed among expenses such as mortgage, car payment, food, utilities, etc. Insurance policies also take up a few line items. You should treat your emergency fund the same way. Don’t let it sit way back on the shelf where it is likely to grow mold or turn sour, because then, when you need it you’ll find that it’s useless.

Whether you put $25 or $100 into your emergency fund is less important than making a regular commitment. The easiest thing to do is put your emergency fund on automatic payment through a regularly scheduled transfer. At first the commitment may be scary, but once the deposit is automated, you won’t miss it.

Just like insurance, your emergency fund will be there when you need, but you hope that you never need it. If you’re not sure what the best option is for your emergency fund, come talk it over with us. We’ll help you sort through the options and find an account that works for you.

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