Emergency funds typically fall into one of two broad categories.
One is set up to handle unexpected expenses — say, when your car breaks down or your water heater springs a leak. The other is there to provide income if you lose your job.
You should have both types, but when it comes to keeping a roof over your head, the second is the most important.
Your personal circumstances will dictate how much money you’ll need if you lose your job.
If you’re the sole wage earner, you should have six to 12 months worth of expenses set aside, whereas dual-income households can normally get away with three to six months of emergency reserves, said Jamie Lima, a certified financial planner in San Diego.
However, if one or both members of a dual-income household work in a sector sensitive to changes in the economy, you might need to save more.
For example, if you’re employed in the travel-and-leisure sector, which experiences a lot of ups and downs (lately, mostly downs), you might need to cover more than six to nine months of expenses.
But if you work in an industry that’s less sensitive to economic swings, such as a public sector job, two to four months of expenses might be enough.
Spouses who both work in the same industry might need to save at least six months of expenses in an emergency fund because both could be laid off at the same time.
When calculating your monthly expenses, focus on the basics, including housing, transportation, food and health insurance, along with any other insurance you might need, such as homeowners and car insurance, said Eliot Pepper, a certified financial planner and co-founder of Northbrook Financial in Baltimore.
Paying off credit card debt and building an emergency fund are both important, but if you must choose between the two, building an emergency fund should come first, says Brandon Renfro, a certified financial planner in Hallsville, Texas.
Because you don’t know when you’ll need it, the money in your emergency fund should be immediately accessible.
Pepper recommends a high-yield savings account that has no fees, requires low (or no) minimums and is federally insured. You can link it to your regular checking account so that you can transfer money easily.
One drawback: Rates on high-yield savings accounts could drop.
One way to lock in a rate for at least a few months is to invest in a “ladder” of short-term certificates of deposit. Stagger them so that each month one matures with enough to cover that month’s living expenses.
If you don’t need the cash that month, reinvest it in another CD that matures at the end of your current series.