Today, Sue Stevens has an article on Morningstar.com on how to setup an emergency fund. Generally speaking, emergency fund is the money reserved to cover your daily expenses in case your income stops. An example of such cases is when you lose your job. There are some debates on how much money one should put in the emergency fund, but an accepted rule is that it at least should be enough to sustain three months of withdraw, the time that you may need to find a new job. And since it is for emergency only, the fund shouldn't be used for any other purpose including invested in stocks. Instead, the money should be kept in a safe place and is easily liquidatable. My approach is that the fund enough for the first three months can be put in a high-yield online savings account (it takes several days for the money to transfer from online account to your brick-and-mortar bank account for you to withdraw) and the rest goes to a longer term CD (such as 6-month or one year) so the money can grow.
Following are the excerpts from the article that answers some other questions.
What's an Emergency Fund? An emergency fund is a money market or savings account where you keep a specified amount of money to cover expenses. You don't touch this money unless it's a real emergency.
How Much Should You Keep in the Emergency Fund? The general rule of thumb on how much should be in an emergency account is to save enough to cover three to six months' worth of expenses. As your take-home pay increases, you may need to keep as much as a year's worth of expenses. The more you get paid, the more you'll need in your emergency fund. That's because if you do lose a high-paying job, it takes longer, on average, to find a comparable position than if you're in a lower-paying job.
How Do You Calculate How Much to Save? One easy way to know just how much you are spending is to take your take-home pay and subtract how much you are saving. The rest is how much you are spending. Multiply that by the number of months you want to cover through your emergency fund.
Should You Use a Home Equity Line of Credit as a Part of Your Emergency Fund? For those of you with higher salaries and therefore greater emergency-fund requirements, you may choose to keep $25,000 to $50,000 in a money market fund and use a home-equity line of credit for any additional amounts needed to cover up to a year's worth of expenses. Just make sure you have a healthy amount of cash saved in very liquid accounts because you wouldn't want to risk losing your house if you couldn't make a payment on your line of credit.
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