Setting up emergency funds

Setting up emergency funds

After you've used your budget to cut your expenses and pay off your credit card debt, you should build up an emergency fund. You should have three to six months of living expenses placed in a safe, secure emergency fund.

The size of your fund can vary, but you should have at least three months worth of normal expenses in it. If your finances are unstable, you should have six months worth of expenses stashed away.

Let's say you're a construction worker. When you've got a job, the money rolls in. But then you can go for weeks without a new job. If you're in a seasonal business like this, you need to have at least six months of expenses saved in a bank account or money market fund.

Although you may be anxious to skip the boring bank account and invest your emergency fund money in something sexier like stocks, building an emergency fund is probably the second-best investment you can make. Paying off your credit card debt is the best.

An emergency fund pays off in two ways. First, it will help prevent you from having to use expensive credit cards. If you face an emergency, you tap into your emergency fund instead of using your credit card.

Second, an emergency fund will help you save on insurance. We'll talk about this in a moment, but with an emergency fund, you can save hundreds of dollars a year by increasing the deductibles on your insurance. With an emergency fund, you can provide self-insurance for smaller claims that the insurance company would charge you to process through higher premiums.