Posted by Mike Smith :: November 13, 2007 @ 6:10 am

A common practice for those trying to allocate their savings into reasonable categories is to set aside some short-term savings for the inevitable unexpected expenses.

Why you need it

We all have unplanned disruptions in our expected cash flow. It can come in the form of an unexpected expense, such as your car breaking down, or an unexpected loss of income, due to layoff or similar. By planning for these situations, you can avoid having to turn to high-rate credit cards to get you through. Of course, readers of the Lending Club blog know that P2P loans from Lending Club would likely be much more affordable than using a credit card if they hadn’t implemented a short-term savings plan yet.

How Much

The general rule of thumb is to have three to six months’ worth of living expenses in your emergency fund. While this number can seem overwhelming, remember to think of your living expenses in the scenario where you need to use your emergency fund: if you’re desperate enough to dip into your emergency account, then you’d probably also be willing to cut back on some of your non-essential monthly expenses. You can use your bare-bones essential monthly expenses as a primary goal, and then increase your amount to include all of your monthly expenses once the first goal has been met.

Where

Most people look to traditional, safe investments for their emergency fund savings needs. These include money market accounts and short-term CDs. These accounts tend to be very low risk and are accompanied by the expected low rate of return. Aside from being low risk, these types of savings methods offer the liquidity that is typically needed to fund the unexpected. If you didn’t need the money quickly, then you could probably think of more lucrative ways to invest.

Building up your short-term savings is a smart thing to do. You’ll be protecting yourself from taking on debt when the inevitable finally comes to pass. There are many ways to save and invest your money, and creating a short-term savings account to handle emergencies is an essential part of all well-crafted financial plans.