Could you cover the cost of a new water heater if yours suddenly went on the fritz? Would you have to put the unplanned purchase on a credit card, and then adopt a Ramen-only diet for months afterwards just to cover the tab?
Having money at-the-ready for life's financial hiccups -- both planned and otherwise -- can cut a lot of stress from your life. Give us just 60 seconds, and we'll show you how to establish a short-term stash of cash in no time.
0:60 Calculate how much you spend every month
The first rule of savings is to bank enough to cover the necessities if -- knock on wood -- an emergency arises. How much do you need? Well, how much do you spend on a monthly basis?
Add up what you spend each month on necessities such as food, shelter, transportation to work, and anything that you promised to buy your kids. (If you're not into keeping detailed records, Mint.com's free online service can give you a pretty good immediate snapshot of where your money goes.)
0:52: Add some padding for "just-in-case" scenarios
There are small emergencies (bad perm) and big ones (job loss). Bump up your monthly spending number a tad to account for things like job-hunting expenses, should you suddenly find yourself in need of a new gig. Then multiply that figure by three or six (for the number of months that you want to cover), factoring in other available monetary resources and the number of people for whom you're financially responsible.
Voila! Now you have the amount of money you need to stash in your emergency savings account.
0:48: Gaze into your 1- to 5-year "big expenditures" crystal ball
With your emergency savings covered, now it's time to figure out what other kind of cash you should put aside. Planning a renovation, extreme dental work or a family vacation? These things are also part of your short-term savings strategy. Put 'em down on paper and estimate how much these purchases will cost.
0:40: Figure out how quickly you will meet this goal
You want to fund your cash kitty ASAP (emergency expenses tend not to wait around until it's convenient). Come up with an amount you can afford to contribute each month. Make it one of those must-pay expenses -- just like your electric bill and grocery money. Yes, it's that important. Once the emergency stash is stashed, move on to the non-emergency short-term savings goals. (Use our savings calculators to crunch the numbers.)
0:37: Pick a parking spot for your cash
Easy access is essential when we're talking about emergency savings, so your money should be stashed somewhere you'll be able to get your hands on it quickly ... in case of, well, an emergency. It should also be in a "safe" investment -- meaning one that won't tank every time the stock market takes a tumble. That narrows it down to:
- High-Yield Savings accounts
- Money Market Accounts
- Money Market Mutual Funds
For non-emergency savings (where you pinky-swear to let the money sit untouched until you need it) less liquid investments -- such as certificates of deposit -- may offer you a better interest rate on your money.
0:29 Click around and comparison-shop
Look at bank ads in newspapers, check out the best national rates on Bankrate.com, see what your broker is paying on cash in your brokerage account, ask your regular bank or local credit union what they offer, and get information on money market funds from websites like iMoneyNet. Find out:
- What interest rates are available
- What are the comparable yields over identical time periods
- What timeframe the rate applies to
- What fees (if any) there are to purchase and maintain the investment
- The minimum investment required to get favourable interest rates
(Investors beware: Some institutions will offer aggressive rates in order to lure you to send them your dinero, only to lower the rates soon thereafter. Check historical rates at Bankrate.com to test the interest rates over time.)
0:17 Just do it
The clock is ticking. There's no time to waste. A short-term emergency fund is one of The Motley Fool's top money "must-haves." In fact, it may be the very thing that saves you from a long stretch of high-interest credit card debt after a fender-bender, chipped tooth, basement flood, or really unfortunate haircut.
0:03: Extra credit: Automate it!
If you're having trouble saving, we highly recommend an automatic transfer program. You can also see if your employer will split your paycheck (direct deposit) between your ordinary account and your short-term savings account, or you could set up an auto-transfer from your checking account into your emergency account.
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