|Why do you need an emergency fund?
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Why you need it
Up until now you may have relied on home
equity or credit cards for unplanned expenses
or emergencies. If you tap home equity, you generally
incur more debt (at least until you sell your home).
If you use credit cards, you are committing future
earnings to current spending. Neither of these is
a desirable financial solution. A savings account
empowers you to use your own funds to meet financial
challenges. And when you're not using the funds, the
bank pays you interest.
|Emergency fund essentials
McBride suggests keeping emergency funds
in a high-yielding money
market or savings account so that the money generates
a tangible return in the form of interest.
"These types of accounts are going
to get a lot more attention now," says McBride.
"There's finally a bit of a premium to be had
on longer term investments." He suggests that
once you have six months of expenses in a savings
account, boost your return a little bit by taking
half of that and investing in a three-month
CD or a short
term bond fund while keeping the other half in
a liquid money market or savings account.
Check out high-yield
rates on Bankrate.
The rule of thumb is to save three to six months of
living expenses -- more if you're self-employed or
the sole breadwinner. But the key is to have a system
of automatic savings that can replenish the account
in case you dip into it. Although three to six months
is the ideal cushion, it's going to take quite some
time to get to that level.
Figure out your monthly living expenses
with this work
sheet. Work out how long it'll take you to get
there with Bankrate's simple savings calculator.
The biggest obstacle to saving is not being in the habit of doing so. So take steps to pay yourself first. Set up direct deposit from your paycheck to a high-yield savings or money market account. This accomplishes two things, says McBride: It works toward building a savings cushion and forces you to live on less than you make.
"Those are really two key steps on the road to financial security: saving regularly and living within your means," he says.