NEW YORK — The amount you stash away in a safe, easy-to-access emergency fund is a personal choice. But if you underfund your short-term savings, you may find yourself banished for years to the debt dungeon.
Here, from the advisers at Motley Fool, is a guide on how to establish a cash fund to cover life's little hiccups:
First, figure out how much cash you need to stash. How much do you spend each month on food, shelter, transportation and allowances for your kids? Bump up this number a tad to include things like job-hunting expenses should you suddenly lose your job.
Then multiply it by 3 or 6, for the number of months you want to cover, and remember to factor in the number of people for whom you're financially responsible. Consider including upcoming big-ticket expenses, such as an auto insurance bill and a maintenance slush fund to cover an unanticipated valve job or engine explosion.
- Next, decide how much you can afford to contribute each month to meet this goal. Make this payment a must-pay expense, just like your electric bill and grocery budget.
- Once you have figured out your target and contribution amounts, pick the right kind of account. Since this is about your emergency savings, you should put that money somewhere you'll be able to get your hands on it quickly. It should also be an investment immune to the stock market's flights of fancy. That narrows the list of places you can park money you need at-the-ready to checking and savings accounts, money-market funds, certificates of deposit and short-term bonds.
- Consider returns. Though your short-term savings will never rival returns on stocks over the long term, emergency cash should still earn its keep, countering inflation and maybe earning a little more. Comparison shopping can help you find out which types of accounts offer the best interest rates, as well as how their yields compare over identical time periods, what it will cost to purchase and maintain the investment, and the minimum investment required to get you favorable rates. For ideas, look at bank ads in newspapers, check out Bankrate.com, and visit iMoneyNet (www.imoneynet.com) for information on money-market funds.
- If you think you might have trouble fulfilling your short-term savings plan, consider enrolling in an automatic transfer program. You can also see if your employer will split your paycheck between your ordinary account and your short-term savings account.
Marshall Loeb, former editor of Fortune, Money, and the Columbia Journalism Review, writes for MarketWatch.