Emergency fund first, and where to keep it
Before you invest a dollar, build a cushion. Here are the safe places to park it.
Why a cushion comes first
An emergency fund is cash set aside for surprises: a job loss, a medical bill, a broken laptop. A common guideline is three to six months of essential expenses, though the right amount depends on how stable your income is.
It comes before investing because investments can be down exactly when life goes wrong. Without a cushion you might have to sell at a loss or use a high-interest credit card. If you carry high-interest debt, paying it down is often part of this foundation too.
Safe places for cash
High-yield savings accounts are bank accounts that usually pay more interest than a standard savings account, and you can withdraw any time. CDs (certificates of deposit) pay a fixed rate if you leave money for a set term, like 12 months, with a penalty for early withdrawal.
Treasury bills are short-term loans to the US government, lasting a year or less. They are considered among the safest assets in the world, and their interest is exempt from state and local income tax (though not federal tax). Money-market funds are investment funds that hold very short-term, high-quality debt and most aim to keep a steady $1 share price. They are very low risk, but not guaranteed. Rates on all of these change over time, so compare current rates yourself.
What insurance does and doesn't cover
FDIC insurance protects deposits at US banks, up to $250,000 per depositor, per bank, per ownership category, if the bank fails. Credit unions have similar NCUA coverage. It does not cover stocks, bonds, crypto or money-market funds, even if you bought them through a bank.
SIPC protects you if your brokerage firm fails and your assets go missing, generally up to $500,000 including up to $250,000 in cash. It does not protect you from investments losing value. Other countries have their own deposit-insurance schemes with different limits.
Alex's essential monthly costs: rent $1,200, food $400, transport $150, phone and utilities $250. That is $2,000 a month.
Three months is $6,000; six months is $12,000. Alex's job is steady, so Alex aims for $6,000, saving $500 a month. That takes 12 months. Alex keeps it in a high-yield savings account so it is safe, insured and reachable.
Key terms
- Emergency fund
- Cash set aside for unexpected expenses, often three to six months of essential costs.
- FDIC insurance
- US government protection for bank deposits if a bank fails, up to set limits. It does not cover investments.
- SIPC
- Protection if a US brokerage firm fails. It does not cover losses from investments falling in value.
- Treasury bill
- A short-term loan to the US government, lasting a year or less.
Build a cash cushion in a safe, insured place before putting money at risk.