The conventional wisdom is that you should have the equivalent of three months' expenses in a savings account for emergencies. But after witnessing the layoffs and hiring freezes triggered by the economy's current malaise, I'm thinking six months makes more sense if you can swing it.
Whether you choose three or six months, the bottom line is that you need a fair amount of cash on hand to cover unforeseen expenses. Ignoring this advice leaves no allowance for the unexpected, like a layoff, a friend in need or a medical emergency for you or a family member. Picture yourself skidding down a mountain on a plastic toboggan with no allowance to slow down or handle bumps; you're doing the equivalent right now if you don't have a few months' expenses socked away.
To give this emergency fund idea a whirl, here are a few tips:
- Be conservative: Ask some folks how much they spend in three months, and they'll just multiply their rent or mortgage payment by three. Of course, that leaves out a lot. In Step 3 of this series, we asked you to figure out how much you spend in a given month. If you had to, you could trim those expenses quite a bit, but it's a good idea to use that figure.
- Put your savings on autopilot: The easiest way to save is to set up an automatic savings plan for which you don't have to remember to write a check or transfer money from your checking account. You might ask your employer or bank to automatically send a set amount from each paycheck into your savings account. You could also have a fund company automatically move a set amount of money from your checking account to a money market account.
- Where to put your savings: As you might imagine, you need your emergency fund to be safe and available at any given time. So, for most folks, the place for this money is a savings account, where your money is insured up to $100,000, or a money market account, where you'll typically get more interest without much more risk.
Some aggressive types might sock this money into the stock market, but that doesn't make much sense because stock prices can fall in a hurry. Think long and hard before you put this money anywhere other than a savings or money market account.
10 Things You Should Do Before You Invest
- Figure out what you're worth.
- Set your goals and figure out how much they cost.
- Spend less than you make.
- Build an emergency savings fund.
- Pay off your credit card debt.
- Insure yourself against the unexpected.
- Contribute to tax-deferred retirement plans like 401(k)s and IRAs.
- Consider using software to keep track of your money and help with your taxes.
- Be your bank's thriftiest customer.
- Check out your credit report.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.