Build An Emergency Fund To Avoid Financial Crisis

By Pinyo, on June 9, 2009

Even financially responsible people do get into trouble and fall into debt. The most common cause is being insufficiently prepared for financial emergencies — perhaps an unexpected sickness or a sudden job loss. As such, having an emergency fund is a vital part of having a good financial health, and is an important step in Moolanomy’s Financial Success Plan.

Why Should You Have An Emergency Fund?

Emergencies happen — the question is: will you be prepared when you have one? You should have an emergency fund so that you don’t have to borrow to survive emergencies and unexpected events. For example:

How Much Should You Have In Your Emergency Fund?

If you don’t have an emergency fund yet, just having $1,000 saved is a great start. Dave Ramsey is one of the key advocates for saving $1,000 for emergencies in his baby steps. Once you have your first $1,000, you’ll want to keep saving. In general, most experts recommend 3-6 month in living expenses. This may sounds like a big goal; however, having done your work in step 2: Earn More and Spend Less…, this should be easier than before.

In this period of high unemployment and sudden lay offs, a good trick is to have 1 month of emergency fund for each percentage point in unemployment rate. For example, the unemployment rate is currently 9.1% so you should have 9 months worth saved in your emergency fund.

Where Should You Keep Your Emergency Fund?

There are two primary requirements when it comes to saving your emergency fund:

Preservation of principal - If you put in a $1,000 you should have a $1,000 or more left the next time you look. It’s okay if your emergency fund is growing slower than inflation, the important thing is that it’s there when you need it.
Liquidity - This means you can get your money when you need it. You don’t have to wait for it to mature (e.g., CDs), wait for the right time to sell (e.g., stocks), or convert it to cash (e.g., gold, collectibles, etc.). The money should be accessible almost immediately — e.g., you can easily transfer it to a checking account or withdraw it with minimal effort.

As such, a high yield savings account is one of the best places to keep your emergency fund. It meets both requirements and it also pays a decent interest rate.

If you don’t have an emergency fund yet, try to put aside $1,000. If you already have $1,000 try to have 3 months worth of living expenses saved. If you have 3, shoot for 6. And if you have 6, shoot for 9 months — the current unemployment rate.

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Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

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7 Comments

Miranda
June 10, 2009, 7:45

I’d never heard the “rule” about 1 month for every percentage in the unemployment rate. That’s a pretty interesting way to figure it. Looks like I have quite a bit of work to do!
Mike from Cash Flow Moe
June 10, 2009, 19:30

I keep my emergency fund in a rewards checking account. The account presently pays 4.00% with no minimums. There are a few requirements such as direct deposit, use of a debit card, etc., but most of these are easily attainable. Check the local banks in your area, I bet you’ll find a similar deal.
ctreit
June 10, 2009, 20:33

I think the size of the emergency fund depends on a bunch of things. For example, a single person does not need as much as married couples with children even if they have the same expenses. – I find it interesting to throw in the unemployment rate, but I also find it difficult to follow this rule realistically. When the unemployment rate shoots up as quickly as it has done recently, who can really boost the emergency fund as quickly to keep up? Especially when the economic environment gets tougher and bonuses, for example, are not being paid?
Pinyo
June 10, 2009, 23:52

@ctreit – Good point about the size of emergency fund also depends on other factors. I’ll update my article to reflect your suggestion.

However, I have to disagree regarding your comment that it’s unrealistic to match your emergency fund to the unemployment rate when there’s a sudden rise. I agree that it’s not easy, but it’s still a good goal to shoot for if you can manage it. I understand that people who suddenly lose their job due to high unemployment wouldn’t be able to achieve this, but the baseline 3-6 months worth should already be there for them.
Ricky
June 16, 2009, 1:49

There is a great possibility of unexpected expenses for which you should have some money with you. Post is giving great detailed knowledge regarding emergency fund.
Charles Richey
June 16, 2009, 18:09

Of course having more money saved is better, but in this economic climate that may not be plausible. IF you are working and are meeting your bills, I think a six month worth is the minimum. Companies are still downsizing and things probably won’t improve until next year at the earliest.
Vinod Kumar
July 25, 2009, 4:56

minimum 5% of total earning should be reserved by every body in this world in above mentioned fund .Dear Sir I have like your blog and add it in my subscription list

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