As a financial planner, when a potential client comes to me with money to invest they often ask, “How should I start investing my money?” They know that they need to invest and have extra capital on hand to do so, but they’re putting the cart before the horse.
Before even speaking with them about their risk tolerance, current investments, potential strategies for future investing etc. I always ask, “How much is in your emergency fund?”
The answers can range from “What’s an emergency fund?” to having hundreds of thousands in a savings account. But more times than not, they don’t know exactly how much they should have in savings.
An emergency fund is a savings account dedicated to bailing you out when unforeseen financial troubles arise. This fund is for repairing your HVAC unit, fixing your car, unexpected medical bills, and especially loss of wages.
The emergency fund shouldn’t be so small that you aren’t able to cover a financial crisis without going into debt; but not so large that you have too much capital allocated in cash.
General guidelines for an emergency fund say it should be around 3 months of expenses for two incomes, 6 months of expenses with one income- for both single and married investors. This is a baseline, but your Emergency Fund should be dictated by your individual circumstances. You and your financial planner should collaborate to determine the amount that is right for you.
Once the proper amount is determined, your emergency fund should be moved into a high yield savings account. Most of us keep our savings at a big bank and receive terrible interest rates for parking our money there. While it may not seem like a lot of extra money, going from an account producing 0.01% interest vs. 1.0% interest just makes sense. Why not let your money earn the most it can for you?
For example, say you have $10,000 in your Emergency Fund:
Interest Rate Amount You Earn/Year
Bank A 0.01% $10
Bank B 1.0% $100
I know, this is not a huge difference, right? But over 10 years, you have received $900 more by utilizing Bank B.
While you will have to pay more in taxes with Bank B, you will still come out well ahead. I encourage you to look at the current return on your savings account, then go here to compare it to other options available. You may be pleasantly surprised what this simple move can do to increase your earnings on the money you have already saved.