Posted on Friday, August 17th, 2007
This is the fourth part of a series on setting up a financial plan.
The beginning of the series is here.
The previous article is “5 Accounts, #2 – Online Savings”.
The next article is “5 Accounts, #4 – Investment“.
I think everyone instinctively knows that they should have an emergency fund, but like many other pieces of financial advice and/or common sense, it often gets put off or bypassed. The cause is the same as that of most common financial missteps – the fact that our brains simply aren’t wired to think sensibly about the future – why plan for a financial disaster which may never come, when we can live right now?
There are too many things which might require an immediate financial “bridge” – major car problems (if you commute by car), a sudden medical expense, an unexpected layoff… if any of these things “catch you short” you could be seriously stuck, forced to rely on a credit card or a loan to get by, at which point you end up in a fresh new financial hole full of unwanted interest payments.
So if keeping an “emergency fund” on hand is a good idea, what’s the best way to go about it?
Since this is for emergencies, it needs to be accessible in short order, so we want something like a savings account or a money market account which will allow us to withdraw/transfer money immediately. So why not use our online savings account?
There are two needs an online savings account doesn’t quite meet.
- We want this money to stay “saved” – mixing it in with all the current account sweeping and discretionary considerations muddies the water, and tempts us to spend “emergency” money on non-emergencies.
- We should be keeping this money around, unused, for the long term. So we need as good an interest rate as we can get, to protect our money from inflation.
A good alternative is an online-accessible money market or high-interest savings account.