The Emergency Fund

The rich have emergency funds. An emergency fund is money that is not used for any purpose that can be foreseen. It is used to let the rich sleep at night: knowing that no matter what disaster may occur in the near or distant future, they have the cash to quickly bail themselves out.

The rest of us should also have this most precious luxury, and we can. How much do we need? That depends on your living expenses. These are the things you need to pay for to survive, the cost to maintain your other assets, and to pay your liabilities or debts. If you're single and all alone in this world, with no one who depends on you, poor you, but lucky you, too, because you don't need as much cash sitting in your emergency fund to sleep at night. Three months of expenses will probably do just fine. But if you have dependents, you should consider amassing an emergency fund that will sustain you and your family for a longer period of time, 6 months is a good rule of thumb.

Be careful to not underestimate your expenses, but don't plan on dining out every night either. You will likely need cash to make changes to your life when the unforeseen strikes. For example, you may need to travel to find a new job, need to move when you do find that job, pay for health insurance, rent another place to live, and you wont want to forfeit travel plans that have already been partially paid for.

Another thing to keep in mind: the smaller your living expenses, the smaller the amount you will need to maintain in an emergency fund, so there is a compounding effect of a frugal lifestyle.

Where do you maintain this small fortune? I recommend high interest earning money market accounts, and places where it will take at least 5 or 6 business days to gain access to the funds. This removes some of the temptation to access your emergency fund to buy a new car or kitchen when its not really an emergency. INGDirect has a great online money market account, and several of the big mutual fund companies have money market funds that i would also recommend. You don't want to invest these funds in a place that would put them at risk of market fluctuations or make them so accessible to yourself you could access them to buy groceries, rent movies, or get into via an ATM.

I like to maintain one years worth of expenses. I use an online money market account, and can't get the money into my hands for 5 business days. The more I saved to accumulate the fund, the easier it was to keep it. I view this fund as the foundation of my portfolio. The fund makes it possible for me to take greater risk with the rest of my investments, and allows me a great sense of security.