Emergency Funds - A Vital Part of Any Financial Plan

Given the state of the economy, as well as people's propensity to spend rather than save having an emergency fund is necessary now, more than ever. I'm sure everyone thinks that job lay-offs, unforeseen medical or automobile expenses, or even natural disasters are problems for the next person to worry about, but then again that's why it's called an "emergency fund" and not the "Christmas account" or "summer vacation to Disney account".

It is always a wise idea, and something I preach (as well as practice) to all of my clients--have a separate account somewhere, anywhere with at least 3-4 months of reserves, but preferably 6-8 months of savings. Why you ask? It is quite simple, actually. With the credit industry in disarray, lenders are scrutinizing new home loan and HELOC (Home Equity Line of Credit) applicants more closely. As recently as two years ago, people's home values were so inflated that they could use the equity in the homes as emergency funds, should the need arise. Now, however, with the number of loans in default and the decline of sales prices (and in turn appraised values) it is more difficult to secure any type of loan leading to the need for a liquid emergency fund. Combine that with the increase in the number of job cuts, and the increased competition for the few jobs that are being created, as well as the rise in fuel and utility costs, you are left with a difficult situation should you be out of work for an extended period of time, or suffer any other emergency.

Simply put, having an emergency fund is also a sound financial planning strategy. If you take advantage of the higher-yields paid by online divisions of most banks, you will also be earning significant interest on the deposited funds. The longer you leave the funds untouched, the more interest will compound. Especially with the talk of rates starting to rise again, the banks will more likely than not follow suit giving you even higher returns on monies that would provide even more relief should you find yourself in an emergency situation. Another related issue that not many people consider is your credit profile.

With a few months of emergency savings, you will be able to continue to pay the mortgage, credit cards, car loan, utilities, etc. which will prevent you from having an accumulation of late notices, or even collections. That in turn will help maintain your credit score which will most certainly come in handy down the road, and is just another added benefit to having a well-funded emergency fund.