Preparing For A Rainy Day Part 1 : The Emergency Fund

One of the first goals one should have with regard to finances is having an emergency fund or buffer. The purpose of this fund is obvious enough: it is intended to tide you over during those times when things happen that may take a toll on your finances. Some of these situations may involve a medical emergency or being between jobs. These are not things that we want or expect to happen, but such is the reality of life. Here are some things to consider in setting up an emergency fund:

1. How much is enough? This is something that would differ from person to person. The usual rule of thumb is around 6 months of one's usual expenses. Personally, I would go for a full year, since it makes sense to provide for a normal yearly cycle. These expenses should include not only the daily expenses that we've been monitoring through our simple exercise (click here), plus other non-daily expenses like tuition fees, maintenance, periodic dues, etc. Of course, one cannot simply wish to have an emergency fund of 6-12 months. The important thing is to make it a goal to stash enough in a given period of time. Knowing how much you get to keep at the end of a month can help you in arriving at a reasonable idea on how long before you can reach your target emergency fund amount.

2. Set up your emergency fund first before committing your money to long-term investments. At the very least, you should have a buffer that can cover for the next few month's expenses, while you are still building up a full year's worth of emergency fund.

3. Don't let your fund sit idly, though. You may want to place it in short-term investments that allow you to "preterminate" once you have need of it, with minimal penalties. At the very least, you'll probably get a lower interest for your money if you preterminate, but that's just fine. Your main concern at this stage is liquidity, rather than profitability. As you build up your fund, you may vary the maturity of your investments so that you can avail of better interest rates.

That's it for now. Next time we'll take a look at another aspect of Preparing for a Rainy Day.


Related Post:

Preparing for a Rainy Day - Part 2

Where is My Money?

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