This past Saturday evening I joined radio talk show host Michael Finney of KGO AM 810 San Francisco on his weekly radio show, “Consumer Talk with Michael Finney,” to discuss my recent post about safe places to keep cash at home. During our conversation I shared with him my Tri-level Emergency Fund Plan, and even though I have mentioned all three levels here separately in the past, I thought it might be nice to present in a single, concise article.
What is a Tri-Level Emergency Fund?
A basic definition of a traditional emergency fund is a pile of money saved separately from other savings goals, and outside of a normal spending account. Its main purpose is for covering emergencies, or required expenses that crop out outside of the normal budgeting process that cannot be cashflowed with regular earnings. A sale is not an emergency, and job layoff, broken transmission or serious illness is – you get the idea.
Emergency funds come in many shapes and sizes, and while experts disagree on the amount that should be saved, everyone agrees that we all should have one adequate to cover some months of required expenses. Whether that number represents one month or twelve months, or somewhere in between, is entirely up to you. I say save just enough to sleep comfortably at night and invest the rest.
Level I: The In-House Emergency Fund
The first $500 of so of your emergency should be something completely liquid (cash) and saved within arm’s length. This amount could be spread out around hiding places in your home, your car, or at your job (or some combination), or could be locked down in a fireproof safe bolted to the concrete slab under your closet. The point is to stash some cash to cover short emergencies that may happen around the home, when using a debit card or visiting the ATM is not possible. Think state-wide power outage, a family member in desperate need of cash, a local natural disaster, etc. Don’t keep your life savings at home, but stashing a few hundred dollars makes sense.
Level II: The Local Emergency Fund
I recommend keeping the next $1,000 of your emergency fund in a local emergency fund at a bank or credit union checking account. These funds would cover things like car repairs, broker appliance and late-night calls to the local plumber. The beauty of these accounts is they are local and have check-writing privileges from a local bank, so most service providers in your area would not give you a hassle about accepting a check. If they did, a quick trip to the ATM, or a counter check from the local branch, should resolve the problem.
Level III: The Mega Emergency Fund
What’s a “mega emergency?” Mega emergencies are the types of emergencies that might require you to live off this fund for a short time. Think job layoff, medical disability, a serious accident, etc. My mom suffered an aneurysm and stroke about a year ago and had to wait six months for disability insurance to begin coverage. Are you prepared to live six months without an income? Most of us are not, and unfortunately, neither was she.
The Mega Emergency Fund is the only place I worry about interest rates, and even then security is a more important consideration. Still, you at least want to stash the money where it will earn a little interest, and the higher the rate, the better. Consider one of the best online banks (read my ING Direct review), or if you have enough saved, a tiered money market account at a credit union may offer higher interest rates than traditional savings accounts.
A tri-level emergency fund is the ultimate way to diversify your cash portfolio dedicated to emergencies, and when fully funded, should help you sleep better at night. It’s been said that there is no softer pillow than money in the bank. After many sleepless nights in the past with an empty bank account, I would have to agree.