Your Emergency Fund: Setting Up a Financial Safety Net
Unforeseen expenses arise from time to time, but establishing an emergency fund can help keep such events from compromising your goals, such as saving for retirement.
BUILDING YOUR BACKUP
An emergency fund typically should cover three to six months' worth of living expenses. If you find it easier to think of your reserve as a percentage of your salary, you may want to set aside 15% to 30% of your annual pretax earnings, keeping in mind that your account should always be tailored to your individual situation. A realistic goal for a two-income household might be an account equal to 15% of combined salaries, since one wage earner may be able to cover basic expenses if the other is unable to do so. On the other hand, a household that either relies on one income or has a fluctuating income might be more secure with an account equal to 30% of pretax salary.
INVESTING YOUR RESERVE
To maintain access to your emergency fund, you should hold the account in stable investments. First, consider a savings account at your bank. A second option could be money market funds, which invest in short-term, high-quality government and corporate debt instruments.* View your emergency fund as security for the short term rather than as an investment in your long-term portfolio. You should build up and then maintain your emergency fund while remaining focused on consistently saving enough money for retirement. And if you must tap in to this account, try to replenish it as soon as possible.