Whether it's a car that needs major repairs or an aging roof that's leaking water, not-so-welcome surprises have a way of popping up in life. An
If you're already setting aside a significant amount of cash for those what-ifs, you're off to a good start. But you also can optimize those savings when you purposefully decide
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How much should you have in your emergency fund?
A solid emergency fund typically will cover three to six months' worth of expenses. But the truth is, there's no one-size-fits-all target. For example, if you're single and your essential expenses take up less than half your take-home pay, setting aside closer to three months of living costs probably will put you in good shape.
If, however, you're the primary breadwinner in a household with kids, or you are a business owner with variable income, a contingency fund that can handle six months of expenses—or even a bit more—might be a more appropriate goal.
3 key needs for your emergency savings
As you consider where to keep your money, look for certain trademarks that can keep your emergency reserves in a healthy position:
2. Principal protection
Principal protection means preserving the value of your initial savings, regardless of the economic situation. To ensure all your money is there when you need it, it's best to avoid investments that carry a significant amount of risk, especially over the short term.
3. Growth potential
To get the most out of your money, you can seek out an account that grows it over time. Generally, the more liquidity and safety you enjoy, the lower your return is going to be. But you still can look for accounts that pay
Where to store your emergency cash
Where can you put your money so you can count on liquidity and principal protection while still generating some positive growth? Consider these four savings vehicles, which provide a nice combo of all these features.
High-yield savings accounts
A savings account at your neighborhood bank is probably fine if you're looking to stow away a relatively small amount of cash. But when you're dealing with larger sums, a
While some limitations may apply, many allow you to make penalty-free withdrawals, providing the liquidity you need for your emergency fund. The FDIC guarantees up to $250,000 of deposits per customer at each member bank, so you know your principal is safe, too.
Money market accounts
Some have tiered interest rates, which means you'll generate higher returns if you keep more money in the account. These interest rates can fluctuate, though, based on the market. Overall, they provide another nice sweet spot with liquidity, safety and growth.
One way around that is to set up a CD ladder, where you hold some money in short-term CDs that you can access in just a few months, and some in slightly longer-term certificates that offer a higher return.
But there are some caveats. You're limited to buying
Where you shouldn't keep your emergency funds
Because a financial crunch can happen any time, it may be tempting to stay overly cautious when it comes to storing an emergency fund. But keeping a large amount of cash in your home—or even in a checking account that pays little or no interest—won't allow your funds to grow over time. In fact, your money will generally lose value when you factor in inflation.
In addition, an emergency fund should be separate from your retirement money. You also want to keep it apart from savings dedicated to planned expenses, like the down payment on a home or a new car. Otherwise, you'll be setting yourself back from those other goals whenever you face an unexpected bill and have to dip into your reserve.
Finally, aim to avoid risk when you're dealing with emergency funds. Chasing potentially big returns can put your principal at risk. Stocks and corporate bonds may be a good choice if you have a longer time horizon, but not when it comes to money you may need to spend on short notice. Typically, you also want to steer clear of putting your money in real estate or any other investments where liquidity can be an issue.
Making the most of your emergency fund
A contingency fund is money that's there for you when you need it most. But even with the best planning, there could still be instances when an emergency fund doesn't cover an unexpected financial setback.