During a financial emergency, it may be difficult for a person to manage the budget. You need to have a way out to prepare for unexpected financial problems and manage the budget efficiently. By setting up a savings buffer, known as an emergency fund, you will be able to pay for your unexpected financial emergencies without having to turn towards family loans, credit card debts, and other borrowing choices that will only add to more stress
Although an emergency fund will not resolve all your financial problems, it’s a good start to move your finances in the right direction. Let’s understand what an emergency fund is and where to put emergency funds.
What is an Emergency Fund?
Setting up an emergency fund helps you plan for serious and unexpected conditions in life and prepare for the expenses that are beyond your daily expenditures. The emergency fund amount can help protect you from getting debts at higher interests when you have unexpected bills or expenses that you cannot pay. The ideal emergency fund can be your first or non-negotiable step towards financial independence that will make your life more stable. An emergency fund provides peace of mind during unexpected financial emergencies, like losing your job, medical emergency not covered by your medical insurance, etc. The fund will make you capable of handling the situation rather than worry about how to survive.
Why You Need an Emergency Fund?
You may think that emergency funds are a perfect option, but you don’t need to create it yet. The reason why you feel this is because you may have a secure job, or you are working in a high demand field where you can easily find a new job. You may think that you can use your credit card to get out of your financial emergencies because you can avail of 0% introductory APR on transferring the balance until you pay your debt.
Every person is likely to face some unexpected financial conditions at some point in time in their life. Below are some examples that can help you understand why you need an emergency fund and the importance of having emergency savings.
- Loss of Income
Getting fired from the job is not the only reason for the loss of income. What happens if the economy crashes down badly, and your field of work is no longer in demand? What if a big company buys off the company you work for and the department you are working in is dissolved, resulting in a laid-off to all the employees in the department. These situations can arise anytime in your life, and to be safe and to manage your finances during the hard times, you need to create an effective emergency fund formula.
- Medical Emergency
A medical emergency is another reason why you need an emergency fund. A medical emergency may pop out anytime unexpectedly, and in some cases, your health insurance isn’t just enough to cover for the medical expenses. If such a situation arises, you can pay them off with your emergency fund without worrying about getting into debt.
- Pet and Child Emergency
If some vehicles hit your pet, you may need to spend some money on vet care.
In other cases, you may feel at some point that your child requires additional education services to keep up at school, which may cost you thousands of dollars every year. These situations may crash your finances if you don’t have an emergency fund. Having a 12-month emergency fund
may help you pay for them.
Some other financial emergencies where you can use the emergency fund:
- A sudden car accident or breakdown
- Unexpected medical expenses
- A family member passes away, and you are to travel at the last minute to the funeral
- A family member is injured in an accident, and you need to take some time off from your work to give essential care
- An unexpected issue with a key system in an owned home like the electrical system, air conditioner, or roof.
Where to Invest Emergency Funds?
Now that you understand the need for an emergency fund, you might be thinking about where to keep an emergency fund. While you are looking for your options, you also need to compare emergency funds vs. savings.
You may have several options to consider when looking to save your emergency fund outside a traditional savings account. Here, we have listed the top available options for you. Carefully consider the risk associated with potential returns and take your investment and saving decisions as per your financial goals.
Remember, you must also pay attention to fees while comparing investment and saving options. While earning bigger returns on your money is a good thing, incurring unnecessary fees can harm your financial battle if you are not careful. Here are some investment options for emergency funds.
- Certificate of Deposit (CD)
It may be the safest investment option for you, but it generally provides only slightly higher returns as compared to an online saving account. Opt for a Certificate of Deposit with no penalty to avoid money loss for withdrawing funds before the maturity.
- Money Market Accounts
Similar to Certificate of Deposits, Money Market Accounts are safe and offer higher returns than online saving accounts. It also includes debit cards, FDIC protection, and check writing privileges. Limited monthly withdrawals, fees, and minimum balance requirements are some of the potential drawbacks of these accounts.
- Money Market Mutual Funds
These investment vehicles can be acquired via mutual fund and brokerage companies. Basically, cash reserves within the investment portfolio earn the interest by purchasing shares in the money market funds while it awaits withdrawal or reinvestment in other investment products. Money market mutual funds invest in safer investment vehicles, such as Certificate of Deposit, short-term debt of bigger corporations, and the government. In these types of funds, money can be accessed anytime. These accounts are not assured with FDIC and may have a high expense fee.
- Roth IRA
If you can contribute to a Roth IRA, you may be able to invest more than $6000 of your after-tax money. The contributions can be withdrawn at any time, as you require, without any penalty.
- Brokerage Accounts
Investing in stocks can provide high potential returns, but you may have to deal with higher volatility. Bonds provide more stability, but for this, you may have to sacrifice higher returns. You need to consider index or Exchange Traded Funds (ETFs) over individual bonds or stocks. You can withdraw funds by selling your assets from brokerage accounts without any penalty, but you may also face taxes on earnings along with transaction fees.
- Health Saving Accounts
If you are registered in the High Deductible Health Insurance Plan (HDHP), you can invest some amount of your emergency funds in Health Saving Accounts (HSA). Most Health Saving Accounts are the same as 401k, where you can decide how to invest money. The investing options depend upon the HSA Company that your financial institution or employer uses.
- A 403B, 457, or 401k
Due to the risk of penalties and growth, you don’t want to put your funds in the retirement account. But, you can take a financial loan or create a hardship withdrawal in a few emergencies.
Don’t just follow the advice of friends, relatives, or something that you read on the Internet blindly. Inflation is a significant concern, and investing in the emergency funds may or may not be a perfect decision for you, and it does not matter what others suggest to you. If you want to invest in the emergency fund, you need to strike stability.
Follow the above-mentioned tips for an emergency fund and invest in them according to your financial situations. You can use an emergency fund calculator to know how much emergency fund I should have.
Take advantage of higher returns and compounding over the long term, while maintaining the ability to address your regular budget needs in a savings account offering high-yield.