How much should be in an emergency fund?
Generally, it’s advisable to have three to six months of living expenses saved in your emergency fund. One of the best ways to determine this figure is for each person or household to create a monthly budget and set a target based on their unique financial situation.
How to save and build an emergency fund?
Once you have determined your emergency fund goal, the next step is to create a plan to achieve the amount needed. There may be a few considerations to determine how to best allocate these dollars. First, it may be appropriate to review all discretionary spending and try to tighten the belt and put on hold some spending patterns until the emergency fund amount is achieved. Second, examine the current saving strategies that are being used. If your employer has a 401(k) plan in which there are matching employee contributions, it may be a best practice to take advantage of these free dollars when possible as the first place for savings. Once the emergency fund is fully funded, it would be ideal to increase the contribution to a 401(k) to 10%- 15% of your pre-tax income or potentially contribute to a Traditional or Roth IRA. Third, it may be important to look critically at any outstanding debt. If there is any amount of debt with higher interest rates, like credit cards, it would be prudent to build an emergency fund while concurrently paying down the principal balance of the debt.
How should an emergency fund be invested?
Ideally, an emergency fund should have a very low-risk, liquid investment strategy while still earning some interest income. There are a few different options available to choose from, each with some pros and cons.
- Money Market Accounts: A money market account is a type of deposit account offered by banks and credit unions. These accounts typically have a higher interest rate than savings accounts, however the rate is usually variable and can fluctuate on market conditions. These accounts are also FDIC insured up to $250,000 per depositor. Additionally, these accounts allow you to write checks and use a debit card for the account. However, one drawback is that money market accounts usually have a higher minimum balance requirement.
- High-Yield Savings Accounts: A high-yield savings account has many of the same features as a money market account. It is a deposit account offered by a bank or credit union that has a variable interest rate higher than savings accounts. They are also FDIC insured up to $250,000 per depositor. One negative aspect may be a limitation on the number of monthly transactions that are allowed from the account.
- Certificates of Deposit: A CD is a savings account that has a fixed interest rate for a specific period of time. There needs to be a lump sum of money up front to purchase the CD, so this may be a better investment option once an emergency fund is established. Typically, the term of a CD will last from a few months to a year or two. At the end of the term, you will receive back the original deposit plus interest. CDs are also FDIC insured up to $250,000 per account. However, there may be an early withdrawal penalty if the money is needed before the end of the term.
- Money Market Funds: A money market fund is a type of mutual fund that invests in liquid, short-term debt securities. Money market funds are held within an investment account, earning an interest rate that is typically higher than a savings account at a bank. There can also be withdrawals at any time without penalties, although it may take 1-2 business days before the money can be moved to another account. While money market funds are not FDIC insured, they may be eligible for $500,000 coverage under SIPC when held in a brokerage account.
As I’ve outlined, creating and maintaining an emergency fund is one of the most important actions that can be taken in an overall financial plan, and yet it’s quite personal to each individual’s circumstances. Life can be unpredictable, so time is of the essence to make sure you have money readily available for any situation that may occur. We recommend that you talk with one of Howe & Rusling’s wealth managers if you’d like to get a better understanding of which options might be most appropriate for your particular circumstances. Thanks for tuning in today!
Disclosures: This material is provided for informational purposes only and should not be considered financial, investment, or tax advice. The strategies and investment options discussed may not be suitable for all individuals, and you should consult with a qualified financial professional to determine the best approach for your specific financial situation. Investment products, including money market funds and certificates of deposit, may carry risks, including loss of principal and interest rate fluctuations. FDIC and SIPC coverage limitations apply to certain accounts, and investors should review the terms and conditions of their financial institutions. Past performance does not guarantee future results. Howe & Rusling, Inc. does not provide banking services. Howe & Rusling Wealth Management is a registered investment adviser with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training.
