I always enjoy reading stories that stress about the importance of having an emergency fund. Here’s one from Vanguard.
With so much publicity about saving for long-term financial objectives-such as retirement, purchasing a home, or investing for a child’s education-it’s important not to overlook the importance of setting aside money to meet your short-term emergency needs as well.
According to David R. Brown, CFP®, a senior manager in Vanguard Advice Services, a cash reserve, or “emergency fund,” should be a part of every investor’s portfolio.
“It’s better to be safe than sorry,” he said. “Nobody can anticipate when the roof will have to be repaired or an appliance will need to be replaced. The idea is to try to find ways to live below your means so that you can save for retirement and other long-term goals but at the same time make it a priority to set money aside in the event an urgent need arises.”
How much should you keep in reserve?
Many financial experts recommend that your emergency fund contain enough to cover at least three to six months of living expenses for your family. However, that’s just a rough guideline. If your job outlook is unstable or if your income tends to be volatile-such as at a commission-based job-you may wish to have a larger cash cushion to meet unanticipated demands.
Starting and building your emergency fund
With gasoline prices at record high levels and prices of many consumer goods on the rise, starting an emergency fund or adding to one can seem daunting. But the benefits outweigh the costs.
“It comes down to getting a grip on your expenses, sharpening your pencil, and knowing the difference between ‘wants’ and ‘needs,'” said Mr. Brown. “If you can limit spending on ‘wants,’ it will be easier to set aside money for an emergency fund.”
How do you take the first step?
Money market mutual funds can be an excellent way to build that emergency fund. They typically offer higher returns than bank savings or checking accounts. And you can choose between taxable and tax-exempt funds, which may be important to investors in higher federal income tax brackets.
You can add to your money market fund through an automatic investment plan that deducts money on a regular basis from a checking or savings account. “It’s important to pay yourself first and build up your emergency fund so it’s readily available to tide you over when you need it,” said Mr. Brown.
The importance of low costs to your bottom line
Costs are particularly important when it comes to money market investments. Because the securities that money markets invest in are very similar, the competitive advantage generally goes to the provider with the lowest expenses. According to Lipper Inc., Vanguard’s money market fund expenses are among the lowest in the industry,* which means you can keep a larger share of the funds’ returns.
Because of their low expenses, our money market funds’ relative long-term performance records are also quite impressive. As of March 31, 2008, all of our money market funds outperformed their respective peer groups over a ten-year period, according to Lipper Inc.**
* As of December 31, 2007.
** For the ten-year period ended March 31, 2008, ten of ten Vanguard® money market funds outperformed their respective Lipper Inc. averages. Results will vary for other time periods. All funds are subject to market risk, and past performance cannot guarantee future results. Funds with at least a ten-year history as of March 31, 2008, were included.
- An investment in a money market mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
- Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund’s trading or through your own redemption of shares. For some investors, a portion of the fund’s income may be subject to state and local taxes, as well as to the federal alternative minimum tax (AMT).
Please make “having an emergency fund” your number one priority towards a secure financial future.