Yes, You Really Do Need an Emergency Fund
Sometimes, life throws you curve balls--be it be an unexpected surgery, a legal issue, or a new baby--some of these surprises (good and bad!) might require you to leave your job or drop a big chunk of change all at once. How are you to pay for your living expenses in the interim? An emergency fund can help.
Where should I put my emergency funds?
An emergency is by nature urgent, and sometimes you need cash on hand immediately. Liquid cash, or money that can be immediately withdrawn is the safest and most common way to store emergency funds. Typically this means keeping that money in a savings account that's connected to your checking account for easy access.
Another option for emergency fund money is my method: I keep my excess cash in a brokerage account, which earns me more money than it would sitting in a bank account. Yes, there are risks involved with this method, but if you are an experienced investor, it's a good option, but keep in mind that gains on stocks are considered taxable income, so you could be penalized at a higher tax rate if you sell stock you've owned for less than a year.
I always pay for unexpected expenses with my credit card so I can earn miles and/or points. Then I transfer cash from my sold securities into my bank account (which usually takes about three days) and pay off my credit card bill in full.
A good "low risk" option for your funds would be picking an index fund, like the S&P 500. With just 11 down years since 1970, it's a good long-term option for your cash.
What's a bad place to keep my emergency fund?
You should stick with easily liquidated funds for your emergency stash, and only keep your emergency savings in a bank account or securities that can be converted to cash quickly. Certificates of Deposits are a bad idea, as they can be locked out for years at a time, and the same goes for retirement funds like 401ks and IRAs. While these could be used in a true emergency, the 10 percent penalty for withdrawing early, plus your tax bill for the funds will not help you in any way.
It's more important to have an emergency fund than to pay off your debt.
Credit card debt is expensive, but in an emergency, you'll want to be able to stay financially stable with as little stress as possible. I would recommend saving about $1,000 in a savings account first, then focus on paying off any high-interest debt you have. Student loans shouldn't fall into this category.
How much should I save?
How much do you think you'll need in an emergency? What if you're out of work for 6 months? A year? This is a very personal question, but I would say the minimum amount you should have in your emergency fund is at least three months worth of living expenses. Six months is more ideal, but if that seems like a tall order start with three. Anything is better than nothing.