Emergency Reserve: How much is enough? Where do I park it?

Emergency Reserve: How much is enough? Where do I park it?

With the tepid economic recovery and current tight lending standards, there is an especially strong need for each of us to build a sufficient emergency fund to ride out the unexpected occurrences of life.

The first step in building your “emergency reserve” is determining how much cash you need to put aside. Financial planners and advisors generally recommend six months to twelve months of living expenses. This could vary depending on your specific financial plan and goals.

The Bell Investment Advisors Financial Planning team takes a strategic approach to this calculation. The proper amount in an emergency fund is unique for each household depending upon its particular living expenses. A larger reserve is appropriate if you worry about job security, medical bills, the rapid deterioration of your roof, etc. Adjustments can be made by reviewing your fixed spending vs. discretionary spending.

In addition to having the right amount of cash, the other essential part of your emergency reserve is that it be liquid, so that in an emergency it is easily accessible. That limits the type of investment you would use for your emergency reserve.

And, of course, among the types of liquid investments, you will want to find one with optimal return. Interest rates are sitting at their lowest point in decades, and the Federal Reserve has vowed to keep them low through 2014. Savvy investors know that keeping cash within a brokerage is not the best strategy because the default cash investment in a brokerage account is a money market fund, which pays virtually no interest.

We recommend keeping your emergency reserve in an online savings account as an alternative to your current bank or money market account. The best online banks do not charge a fee and are FDIC insured. You want to make sure the bank you use is covered by FDIC insurance, which is a safety net covering a maximum of $250,000 per unique account registration per institution.

Currently most savings accounts, CDs, or money markets are providing between 0.1% and 0.4% in annual interest for holding your cash. Online banks are able to provide a slightly higher rate, currently 0.8 to 1.0%, because they do not have the expense of operating physical business sites. This significantly reduces their overhead costs, a savings which can be passed on to customers in the form of higher yields.

If you do not have an emergency reserve already, we strongly encourage you to speak with a Certified Financial PlannerTM to establish one. It is essential that you determine the appropriate amount to store away in cash based on your household needs and your specific Financial Plan. Financial Planners can also help you find the most productive online savings bank for your cash.

Building your emergency reserve is only the first stage of protecting yourself financially. For the complete mechanics of developing and implementing your cash reserve plan, see our previous blog post: The Power of Three: How to Maximize Cash Reserves.

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