How To Build a Smart Emergency Fund

Responses to this post (7 comments)

  1. 1/27/2011
    11:25 am
    AG says:

    I believe plastic can’t be considered as a form of emergency funds in anyway. One reason for the same is that one form emergency is having trouble getting that paycheck from your employer and in such a situation, using credit cards in just adding to your problems. I personally use my Savings account, have almost 6-8 months of expenses docked there ;)

    • 1/27/2011
      6:11 pm
      Ally says:

      Nice, AG! Thanks for sharing and your feedback.

  2. 1/27/2011
    2:08 pm
    Robert Prather says:

    I like the idea of having different tiers to your emergency fund. Perhaps keep $1000 in a savings account and then anything above that put in a Roth IRA if you qualify and/or if you aren’t already maxing our your Roth (which I hope you are!). Otherwise put ~3-6 months expenses in a CD latter so you can have quick access to the funds and get the best FDIC-insured interest rates possible.

    • 1/27/2011
      4:33 pm
      Ally says:

      Thanks for sharing your advice with our readers, Robert! Maybe somebody will be inspired by your example.

  3. 2/13/2012
    9:47 pm
    James Mortensen says:

    Hi Robert,

    Can you elaborate on using a Roth IRA for an emergency fund? I’m a long way from retirement, so wouldn’t I have to pay a hefty penalty for withdrawing money from my IRA if something happened? From what I understand, the penalty would be in addition to losing interest from closing the CD early, as well as any tax penalities assessed by the IRS.

    Thanks,
    James

  4. 2/13/2012
    10:29 pm
    James says:

    I wanted to elaborate on the statement about using credit cards in an emergency. In terms of minimizing risk, it’s best to opt for the savings than the credit. Here is why:

    First, if you have 3 to 6 months of expenses saved in a money market or savings account, and you lose your job, you have 3 to 6 months of financial cushioning in order to find a viable replacement for your income. While searching for a new boss, you have no one to answer to except yourself. The idea is that since you’ve saved enough money to cover expenses for 3 to 6 months, you could theoretically go 3 to 6 months without employment without hurting your credit.

    However, let’s say you instead rely on your credit cards for emergencies, and the emergency happens to be the job loss. While the credit card may help you pay your bills, it won’t help you get cash. Additionally, the cash rates on most credit cards are generally 20% or more, and payments you make on your cards are generally applied to the lowest APR balance first, not the hefty 20%+ cash balance.

    Most importantly, if you are out of work for 6 months, how should you plan to pay your credit card bills for 6 months if you have no income? As many of you know, the moment you swipe that card, you have a balance. That minimum payment that you must pay to the credit card company must be a cash equivalent, (i.e. not debt), and the credit card company is going to want you to start paying that minimum payment within the next 25 days.

    So, where does one get the money to pay the credit card while one is in the clutches of a true, long-term emergency, such as being out of work? This seems to me to be a very risky situation.

    In the first scenario, with a nice sized emergency fund, I mentioned that you only have to answer to yourself. While your savings account won’t call and harass you if you don’t re-fund it soon, you can bet that your credit card company won’t hesitate to contact you if you miss payments. Your savings account will still be there for you later on when the sun shines again with that same rate, but I guarantee you your credit card company won’t be so forgiving with how much they raise your rates for your missed payments.

    This credit-card-as-an-emergency-fund mentality can lead to massive amounts of debt, missed payments, unneeded stress, bad credit, and low self-esteem. It’s best to be self-insured against these kind of emergencies. It will cost you less in the long run, and the only creditor you’ll answer to is yourself.

    With that said, I can see how one might balance risk by keeping some money in the bank to offset minimum payments while relying on credit cards for some expenses. I don’t necessarily think it’s a black and white issue, but I don’t agree with the idea of $0 savings either.

    if someone can find Ms. Weston’s original article, I’d love to read it so I can get the full picture of what she was suggesting. The link in the blog post is broken, and I can’t find it anywhere.

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