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MoneyRates Monthly Resolution #6: Build (or Rebuild) Your Emergency Fund

June 01, 2010

| MoneyRates.com Senior Financial Analyst, CFA

At the beginning of 2010, MoneyRates.com published a list of 12 monthly resolutions designed to help Americans improve their savings rates. The storm clouds are clearing, the economy is perking up, and even the job market is strengthening a little. With recovery in the air, this is a perfect time make building (or rebuilding) your fund your June MoneyRates.com resolution.

Why is economic recovery a good time to build up your emergency fund? It might seem counterintuitive--after all, aren't we almost out of the woods? But there are several reasons why you shouldn't ignore building an emergency fund during an upswing.

First, you're more likely to have some extra money when times are better. Maybe you've gotten used to frugal living during tight times--if your income picks up, you might try to keep your expenses the same and use the difference to increase your savings rates and give yourself a better financial cushion.

Second, during the recession, you may have raided your money market account or savings account and now need to make up what you took out. A recent poll conducted jointly by MoneyRates.com and GetRichSlowly.org asked readers about the number of months' expenses they had in an emergency fund. The responses in May 2010 were strikingly different than the responses in January 2010. Many more reported fewer months' reserves in May than in January, suggesting that the intervening months had sapped the rainy day funds of many readers.

It's natural to have dipped into your emergency fund during a tough economy--that's what it's there for--but you should take the first opportunity to build it back up.

Four Tips to Build Emergency Funds

So how do you go about building this emergency fund? Here are four tips to keep in mind:

  1. Three to six months of expenses is a good starting goal. This size of fund tends to be the consensus among experts. It's a somewhat arbitrary figure, but it's a good target for starters. If you're trying to pay down debt, the ideal size of your target fund is more debatable, but many financial advisors would agree that some small emergency reserve is worth building up even as you're trying to cut down debt.
  2. Adjust your reserves upward as your expenses grow. Keep in mind that three to six months' worth of expenses is likely to be more money when you are 35 than when you are 25. Make sure your emergency fund adjusts realistically to your current financial obligations.
  3. Try to keep lengthening your reserves over time. Once you reach six months' worth of reserves, don't stop adding to your emergency fund as you can. The recent recession demonstrated that periods of unemployment are often much longer than three to six months.
  4. Choose the right deposit vehicle for your reserves. Emergency funds are a good fit for money market accounts. Even if there are account restrictions such as a limit on the number of withdrawals per month or minimum balance requirements, you should be able to meet them easily to earn money market rates. Intermediate-length CDs are appropriate for longer-term reserves.

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