Although some consumers worry that money sitting in a traditional savings account accruing little annual interest is, essentially, wasted money, there is a premium to having funds that are accessible. In a true emergency, you may need to access your funds right away and may not have the luxury of waiting days, or even weeks, for them to transfer from other types of accounts. You can also shop around for a high-yield online savings account so your emergency savings account is earning interest while it’s parked for future use.
While you may want to consider using an online savings account for the first couple months’ worth of expenses, think about putting the rest of your emergency savings in a money market account or a certificate of deposit (CD) to earn additional interest.
How should you save for your emergency fund?
To help keep your savings goals on track, make your emergency fund contributions part of your monthly budget. Bonus: You can automate your savings to remove any chance that money you planned to save for emergencies will be used for something else.
Making automatic deposits each month is easy. Just choose the amount you want to contribute to your emergency savings account, and then set up a direct deposit to take the money out of each paycheck. You can also set up an automatic transfer each month to move money from your checking account to your emergency fund.
“It’s out of sight, out of mind,” says Kerri Moriarity, head of company development for a Boston-based startup building financial software. “Since the transfers happen automatically, it eliminates the ‘pain’ of choosing to transfer money out of your checking account to set aside for an emergency.”
Should an emergency fund come before paying down debt?
Experts have different opinions on whether or not you should save for an emergency when you have credit card debt to pay off. While many decide to postpone saving when they have credit card debt, Marc Roche, co-founder of a blog about investment strategies, offers another recommendation.
“While there is financial truth that it will cost you more to pay double-digit interest on a debt balance when you’re lucky to make 1 percent interest on your savings, there is a cost to the risk of not having savings,” he says. “If you had a financial emergency and no cash, you’d have no choice but to turn to high interest credit cards and loans, or worse, foreclosing on your home and even bankruptcy,” Roche adds.
But what if you are paying 15 or even 20 percent in interest on your credit card debt? There may be a point when it makes sense to divert extra funds to paying down this debt before going into savings mode for your emergency savings account. The key is to find a sweet spot where you can pay down your debt and still contribute to emergency savings each month.
Building your emergency fund—and beyond
You should now be able to answer the question “what is an emergency fund?” and see that an emergency savings account will provide you with a safety net and peace of mind if you come face-to-face with an emergency. However, it’s important to remember that you can’t just set up the account and forget about it. If you find yourself in a position where you need to dip into your emergency savings, be proactive about replenishing your account so it’s ready to go for next time.
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Source: discover.com