June 14, 2012
Many factors contribute to the overall state of an individual’s financial health and one such factor is the ability to plan ahead. Assuming a big-picture mentality will help you understand the importance of planning for the future and one of the smartest strategies for doing so is to start an emergency fund.
What is an Emergency Fund?
An emergency fund is the ultimate slush fund, intended to cover the unplanned expenses that arise when life throws you an unexpected curve ball: a job loss, a house flooding, an illness. Since this is a fund that you will ultimately depend on to get you through any unpredicted financial setback, it must be completely reliable in its ability to provide at any time. Therefore, it would better serve you to allocate this cash to a savings account, where your funds are guaranteed, as opposed to investing it in the stock market.
An effective emergency fund should also hold liquid or short-term, accessible investments. In the ideal scenario, you won’t ever have to dip into your emergency fund for immediate costs and you can continue building it as a long-term investment that may eventually go into your retirement fund. A more realistic situation, however, predicts that there will be certain occasions in which these types of immediate costs do crop up and will require you to access your savings. To make the most of your investment, it is a good idea to split your emergency fund into two separate accounts based on specific needs:
Short-Term Emergency Funds
- Use for smaller, immediate emergencies (having a car repaired, replacing a laptop)
- Use to hold you over until you’re able to access long-term account in the event of a more serious emergency
- Store in easily accessible account; one that bears little interest
- Account should have debit card attached, check writing privileges
Long-Term Emergency Funds
- Use for bigger, more extreme emergencies (natural disaster, medical costs, job layoffs)
- Account accessibility is less important (if you have short-term fund, this can cover you during the time it takes for your long-term funds to liquidate)
- Store in account that earns slightly higher level of interest
Essentially, an emergency fund gives you a form of financial security that you can depend on to help you out in a bind. It is never too soon to start building your emergency fund; getting an early start will help reinforce good money management habits and give you more time to grow your savings.
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