Introduction to Emergency Fund
An emergency fund is a certain sum of money which you set aside to use it in case of an emergency. You need to be cautious where you put your emergency money. Most people put it in a savings account and not confuse it with their money in the current account and use it for their daily expenses. Some feel they can invest out of their emergency fund as it will fetch them some good returns until they need it in some emergency. As per the expert’s suggestion, an emergency fund is saving at least three to six months of total earnings or expenses in advance that will come in handy while we need it.
There are two types of an emergency fund. Short term emergency fund where you might withdraw for an immediate emergency and a long-term emergency fund which you might need when you lose a job or face a natural disaster. Any fund which you cannot access immediately goes into long term emergency fund. An emergency fund is not used for entertainment purpose. It is identified and used only for true emergency purposes such as job loss, natural disaster, unexpected home or car repairs, failure of major electronic appliance, sudden need to travel, etc. One might be confused if he/she must invest the emergency fund or leave it as it is. Here are some ideas on what to do with your emergency fund.
Reasons on Why you must not Invest Your Emergency Fund
The best way is to put your emergency fund in a savings account that has a good interest rate like 3.2% and helps you to earn more. Some banks have savings account with 1% interest rates which is one main reason, many consumers think of investing their money instead. But think while you are in urgent need of your emergency money and the market takes a downturn. You will end up surviving with only a very less emergency fund in such a crisis. Even worse will it be when you are unemployed and have no other option but to depend on your emergency fund that has not got any returns? Surviving on a small emergency fund is not of any use. Even if you invest in an emergency fund, make sure you do not withdraw it when is the market is very low. Added, you will have to pay an extra fee or penalty for withdrawing it before the maturity period when you are in an emergency crisis. This fee is at least three months of interest. If you withdraw too early, you also lose money on the principal. In a nutshell, there is not much growth if you invest your emergency fund in any investment which you might withdraw before it matures.
Best time to Invest your Emergency Fund
There are times when investing your emergency fund works. Retired people who have spouse support who still works can aggressively invest their emergency fund. Withdrawals could be penalty and tax-free for them. The consumers can get high returns when they invest in low-risk emergency fund investment. If you are the type of person who is always tempted to withdraw the money from their savings account, can invest their emergency fund in a safe place and not able to withdraw them as and when they want. The only downside will be that you will not be able to withdraw the emergency fund invested before the maturity period without making a penalty.
How to Build Your Emergency Fund
Make sure you have a small amount of money automatically saved up by setting up automatic transfers from your bank account each month. There are many effective ways to build an emergency fund. Break it down. Figure how much you can afford and save up each month and how long you need to invest to reach your emergency fund goal. This is manageable for anyone. Check for money leaks in your monthly budget like outside food, wasting on electricity bills and such and add it up each month to your savings. Make it automatic so that part of your salary directly goes into your emergency fund each month. Use the spare change in a jar each month, and this can supplement your emergency fund. Celebrate when you reach your milestone each month as a way to encourage you to save more emergency funds for you and your family.