In our last installment we went over paying off emergency debts.
- Credit card debt, personal loans, and any “high interest” debts qualify as emergencies of their own and take priority over trying to build up a cash cushion.
- DO NOT SAVE FOR EMERGENCIES IF YOU ALREADY HAVE CREDIT CARD DEBTS! THEY ARE AN EMERGENCY!!!!
- Generally, mortgages and student loans are the only “good” debts to be comfortable with paying off over the long-term.
Now that you’re out of debt you’ll want to build up a cushion to avoid having to resort to high interest debt for covering unexpected (or normal!) expenses. The idea here is to build up a safety cushion of savings to use when your car breaks down, the dog gets sick, your roof starts leaking, or you get fired. Otherwise you’ll have to resort to using a credit card or some other loan to cover the costs, meaning you’ll be increasing the overall expense. You may be tempted to use a credit card and hope to cover the bill before the next statement comes due, and sometimes for small expenses you can do that. But in the case of losing a job you won’t be able to keep earning; and in larger expenses you likely won’t have the cashflow to cover it in time.
You’ll get numbers all over the place here, and I’ll throw some more at you myself. Any amount of emergency savings is better than none. I’d say you should start with a clear cut number, like say $500 – $1000 as a starting point. Once you’ve built up that amount, you can continue to increase your goal until you reach a month or two worth of expenses. Each dollar you save beyond that is less important as the likelihood of encountering multiple unplanned expenses or large expenses is lower. It really depends on how reliable your job is, your budget, and your personal preference. Many advisors will state 3-6+ months of expenses, and I think once you get to larger numbers like that you’re leaving too much money to sit around without any good return – unless you happen to have a very volatile/uncertain income.
OK, so now that we’ve gone over why you should have some emergency savings, the next question is where to keep it. Obviously the whole point of having the savings is to have quick access to some fast cash to cover bills. That means we don’t have a lot of options for where we can put it. The most common place is in a “High Interest” savings account (which aren’t really high interest right now). Personally I used an ING Direct account for this purpose, which has now since become Capital One 360. The only other I’d suggest looking closely at is SmartyPig, though I have not tried it personally.
Currently “High Interest” online savings account don’t really offer much in the way of a return. You’d be hard-pressed to get close to 1%. You can always research more thoroughly, but I don’t bother chasing higher returns than the 0.75% Capital One 360 is offering right now, since it tends to be competitive and the difference in rates here tends to mean very little in the way of returns for me (see below for why…)
I don’t recommend using any other vehicles like CDs, bonds or money market accounts. Stick with a local bank or credit union, or an online savings account. The other vehicles require some amount of “locking up” the funds for the higher returns they offer – usually for some set period of time and/or with limits on withdrawals. For example with a CD you’ll typically forfeit a given period worth of interest.
For those of you who have a good amount of savings, you may be able to do some more interesting things to more aggressively grow your savings without needing such a large amount of money in savings accounts. Obviously it sucks in our current climate to have a large position of cash sitting around in a bank which is paying less than 1%. if you have a lot of home equity you could use a Home Equity Line of Credit (HELOC) as a means of securing access to a large amount of cash for rainy days. This requires a very dedicated saver to even consider, however, since you’ll be using collateralized debt to cover expenses (in plain speak: you could potentially lose your home).
For me, I keep around a month or two worth of expenses in a savings account, but then have a brokerage account which I could liquidate in a 1-2 week time frame for major expenses. This way I have access to cash immediately to cover a month’s worth of expenses, and while that’s happening I can start the process of selling off some of my holdings in VTI and then transferring it out to my savings/checking at my bank.