Emergency funds are important for people who want to add some extra security to their lives. Emergency funds enable individuals to save a comfortable amount of money for their particular situation, which would provide a nice cash cushion in the event of an emergency.
Emergencies could include but not be limited to losing your job, to medical emergencies or unexpected house repairs. Having an amount of funds ready to be deployed against those emergencies will smooth your financial situations against the unexpected financial outflows created by the emergency. Having the line of credit could potentially be helpful in the extreme situation that you need it only if you can repay it quickly. Using a line of credit would also let you save and invest the money that you were planning on using for your emergency fund at a higher rate. The problem with using a line of credit is that if your emergency is serious enough that you cannot repay the line of credit quickly enough, then you will be compounding your misfortunes and end up in a very bad situation in the end. For example many homeowners in the US treated their houses as ATMs by taking home equity lines of credit against their home equity. Having the ability to cash in on your home equity was a viable line of credit for most homeowners to consider. But once the house bubble burst, fewer homeowners qualified for equity lines of credit.
There is however a large debate over whether one should actually save a lot for an emergency fund or whether creating a line of credit equal to the expected amount of the emergency fund would be a more efficient strategy.
Another debate about to emergency funds is related to the amount of money and the number of month’s worth of living expenses your emergency fund should be covering. Some people believe that three months worth of living expenses is enough, while others believe that twelve months is a better figure to consider.
Last but not least one has to consider how the emergency fund should be invested. One could open a high yield savings account or create a CD ladder in order to not only save for emergencies but also earn a decent rate of return. In the next post I will be discussing your options related to investing your emergency fund.
The article was included in the Carnival of Personal Finance #210 – Punch Out Edition
Wednesday, June 10, 2009
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1 comments:
I think part of what needs to be considered is what is generally accepted for the emergency fund to cover. For some people, this might be emergencies such as a car break down or a water heater that stops working. For others, this might mean being totally unemployed with no income for up to a year. That's why I struggle with how much of an emergency fund to have, because there are varying levels of emergencies... although I would say that more money is a better buffer, in general.
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