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Financial Literacy - Emergency fund
OVERVIEW
Preparing for all contingencies
Unless you like living in crisis mode, it's essential to have an emergency fund. Learn basic strategies for building reserves.
Creating an emergency fund

Why do you need an emergency fund?

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.

Savings guidelines
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.

Getting started
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.

-- Posted: July 23, 2007
 
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