Paying Unexpected Expenses
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What do you do about this?
The answer for paying unexpected expenses is an emergency savings account.
An emergency savings account is a sum of money set aside in an account that is only used for paying unexpected expenses.
Unexpected expenses come in many varieties and range from a roof leak to a job layoff.
How much do you need in your emergency savings account?
There is no hard and fast rule here, only some rules of thumb.
If you are still paying off your unsecured debts it is generally accepted that $1,000 is an appropriate amount until you have become "bad debt" free.
If you have nothing more than a mortgage payment or perhaps are completely debt free the common recommendation is that you have 3 to 6 months living expenses put aside. Now this is where it gets tricky. Everyone will have different requirements for 3 to 6 months living expenses. The general rule of thumb is to have at least $10,000 available.
This is just a rule of thumb and you will have to do some thinking for yourself here. If your mortgage payment is $2,000 each month then $10,000 surely will not cut it. On the other hand if you are debt free $10,000 may be a nice cushion. Once you are living on a monthly budget it will be easy to determine how much you will need for your emergency fund. Do not skimp on your emergency fund.
Where should you put your emergency savings account?
In general your emergency savings needs to be readily available. Money market accounts are usually the best choice.
Unfortunately money market accounts and other short term savings vehicles are not real money makers, but you can access your money quickly and do not have the threat that it will decrease in value.
The reason that I like money market funds, is that they will make a return comparative to other accessible investments, most have check writing capabilities, and your investment is relatively safe.
There are other options to money markets such as interest bearing checking accounts, savings accounts and possibly other savings vehicles in various banks, investment institutions and credit unions. Choose the investment that is available to you and fits the criteria.
One thing to be aware of when choosing a money market or any investment option is the expenses. Expenses will vary widely among investment firms. Ideally you want to find an account that lets you invest in the money market with no up front or back end fees and minimal yearly expenses. Since a money market does not appreciate quickly it would take a long time to make up for high expenses.
An up front fee means that they will take a percentage of your money when you initially invest it. For example it you invest $1,000 and the fee is 5%, they will take $50.00 out of your account and you will only end up with $950 invested.
With a back end fee they take a percentage when you withdraw your money.
All investment firms will charge an annual expense on your invested money. Just pay attention and choose one that has a lower expense. Be careful, since some will suck you in with a low initial expense that will be raised after a certain number of months. Look at the track record going back a few years to make sure that the expense ratio has stayed consistent.
Make sure that you have an emergency savings account so that paying unexpected expenses does not chase you back in debt, it is a vital step in living without debt.
I have my emergency savings account in the Prime Money Market Fund at The Vanguard Group.
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