Avoid a financial trainwreck: Have an emergency fund!

I have done quite a bit of reading and everyone seems to have differing opinions on how much of a cash emergency fund one should have at hand at all times. I read many different angles on it and have formed my own educated decision. The money should be in a separate, interest bearing account like a money market, savings, or CD. I prefer CD as I earn more interest if I don't use it and pay a small penalty if I do. It also makes it a little harder to get at the money and you will think twice before spending it!

For those of us who have "normal" salary or hourly jobs we should have about 4 (minimum) to 6 (maximum) months of living expenses. You arrive at this number by looking at your monthly budget and multiply the total by 4 (or 6) and that is the target. Self employed people should have at least 1 year saved. This may sound excessive but in a recession like our current economy it can be very handy when work is harder to come by.

Your emergency fund is exactly that and should not be used for any other purpose. I define it as the money I will use to live in the event I lose my job and am forced to look for another. This protects your sanity and your credit and you do not have to rely on unemployment (assuming you even qualify). Only other purpose I can think of is to use the money for expensive medical bills or repairs on a car or home. Basically you save it to make sure your life is not interrupted due to some event beyond your control.

If you do use the funds for any of the above purposes it must be replenished as soon as possible. I would even argue that debt payments should go down to the minimum until you have it built back up. Paying off debt early is always good but if you have little or no emergency money you will be unable to pay the minimums if something were to happen. This leads to higher interest, collections calls, and bad credit marks. It is worth paying a little interest today to avoid this in the future.

Do you have an adequate emergency fund? Is it invested safely?