Emergency Money Fund: Building Savings in a Low Interest Rate Environment

Building Savings in a Low Interest Rate Environment

Having an adequate emergency money fund is the foundation of a solid financial plan. Just as you would place a solid foundation before building your home you need a solid emergency savings fund for unexpected needs.

Emergency Money

Emergency money is money kept safe and separated from all other activities including your investment portfolio. Emergencies are unplanned events that cannot be foreseen or predicted such as losing your job or extraordinary medical expenses. Needing a new appliance or repair is not an emergency but an ongoing expense that should be budgeted for.

The lack of emergency money leads families to borrow at high interest rates, sell assets in a distressed situation, or borrow from family or friends when unplanned events occur. Statistics show Americans are dangerously illiquid. Making plans to have emergency money can give you peace of mind, reduce stress, provide extra income, and provide the foundation for a solid financial plan.

Building an Emergency Fund

Most financial experts recommend an emergency fund equal to 6 -12 months of expenses. Since one of the main emergencies we want to protect against is losing a job, I think being conservative and saving 1 year of expenses makes sense; after all, it’s taking a long time to find a job today.

I like to use three tiers of liquidity for my emergency fund.  I keep $5 – 10 thousand dollars in a money market fund. A money market is ultra-safe and extremely liquid. Money markets allow you to write a check to meet an immediate need.

My second tier is $15,000 + in a bank certificate of deposit (CD) which pays a little interest and provides for my banking relationship to be completely free. Two or three checking accounts and a few services can add up to $20-40 in bank fees. Saving $240 per year in banking fees provides a 1.6% return on a $15,000 CD savings account. Saving $480 per year in fees provides a 3.2% return on a $15,000 CD. There is no reason to give any of your hard earned money to a bank for fees; plus you earn interest on your CD.

My third tier of emergency funds is placed in United States Government Saving I-Bonds. Many years ago I started putting a few hundred dollars a month into a Treasury Direct account tied to my checking account. The $30,000+ in that account is now earning 3.06% (current rate from Nov. 2011 to April 2012). This money is a little less liquid but safe and available for large emergencies.

Emergency Savings

Emergency savings will give you the ability to meet your unplanned needs and avoid borrowing at high interest rates or selling assets at distressed prices. A segregated emergency money fund will provide peace of mind knowing your financial plan is built on a solid foundation for meeting your needs and long term wealth building.