Christine Benz from Morning Star
Emergency funding is a very important aspect of financial planning, regardless of your life stage or circumstances.
Having emergency funds for those who already have high debt can help prevent relying on additional, high-cost financing in a pinch. It also helps you to pay for unexpected costs without having to raid your retirement account.
Finally, a big reason to have emergency funds is to cover basic costs in the event of unemployment.
Step 1: Determine your monthly living expenses
Aggregates your important monthly expenses: housing expenses, utility, food expenses, liabilities, insurance, and tax services. Do not include non-essential items that can live in a pinch.
Increase the required living expenses by three months. This is the Emergency Fund’s absolute minimum savings target.
From there, you can customize your own emergency amount upwards. One of the biggest determinants of emergency size is career pathway. Contractors or other workers with a lumpy income stream should clearly have a larger cash buffer.
Finally, consider the flexibility that requires cost adjustments downward in a pinch. New graduates who can easily relocate or acquire roommates can escape with smaller emergency funds. But if you’re carrying a mortgage, have two cars payable and have children, the emergency fund should be much larger.
Step 2: See how much you have now
Total investments held in checking and savings accounts, money market accounts and funds, savings account certificates, or CDS. It excludes assets allocated for other purposes, such as money you’re saving for a down payment on your car. Also, exclude cash holdings in stocks or bond mutual funds. This is your current emergency fund.
Step 3: Set emergency fund savings goals
Subtract the figures for Step 2 (current Emergency Fund) from the diagram for Step 1 (Target Emergency Fund). This is the amount you need to save to a minimum. Postponed above this level. Putting your money aside to achieve this savings goal must be your primary savings priority in the coming months.
Step 4: Identify the right investment
My advice is to use a Plain-Vanilla Cash Investments: Checking and Savings account, CDs, and Money Market accounts. Online savings accounts are often one of the best cash options. Credit unions often provide appropriate yields.
Remember that not all product types have FDIC insurance when you purchase cash options to fill your emergency funds. Money market mutual funds, for example, did not qualify for FDIC protection, but were actually very safe. And remember that if you need to prematurely put your money out, there is a penalty on the CD.
Step 5: Find the right container
Finally, it is important to have access to emergency assets in a pinch. There is no need to deal with taxes or penalties. Therefore, it is ideal to maintain the emergency fund outside the scope of your retirement account.
However, a Ross IRA can help you back up your emergency funds when necessary. While it’s not ideal to use your retirement savings as a piggy bank, you can always tap on a Roth IRA donation for some reason.
If you’re a homeowner, it makes sense to increase your emergency funds by setting a credit line for home equity to use in emergencies. That way, if you realize you’re really tied up and have to run out of emergency funds, you’ll have another safety net in place.
This article was provided to the Associated Press by Morningstar. For more personal financial content, visit https://www.morningstar.com/personal-finance
Christine Benz is director of personal finance and retirement planning at Morningstar.
Related links:
1. Investment Guide for All Life Stages https://www.morningstar.com/personal-finance/an-investing-guide- Every-life-stage2. Short-term investment https://www.morningstar.com/financial-advisors/
Original issue: February 28, 2025, 5:17pm EST
