THERE’S NOTHING LIKE a pile of cash to ease our financial worries. Indeed, while today’s spending often brings only fleeting pleasure, not spending that money—and instead building up a cash cushion—will likely deliver ample long-term happiness.
Consider stashing that cash in a low-cost money-market mutual fund or a high-yield online savings account. These accounts should pay more than a savings account at a brick-and-mortar bank, plus separating our cash cushion from our everyday bank account will likely make us think twice before dipping in.
We can think of this cash as our emergency fund—the place we go for extra money if the car breaks down or we get hit with surprise medical expenses. The biggest financial emergency, however, is losing our job. How likely is that? How long would it take to find another job—and how much would we need to cover costs in the meantime?
One rule of thumb: Keep enough emergency money to cover three to six months of living expenses. To figure out how much that is, get your latest pay stub and see how much you take home each month, after taxes and any retirement plan contributions are deducted. From that sum, subtract any additional monthly savings. That should give you a reasonable estimate of your typical monthly spending.
Look to save the full six months of living expenses if your job is tenuous or you’re self-employed. Go for three months if your position is more secure, your spouse also works, you have a home-equity line of credit, you have other savings in a regular taxable account or you’ve funded a Roth IRA. You can withdraw your regular annual contributions to a Roth at any time, with no taxes or penalties owed—provided you don’t touch the account’s investment gains.
Next: Step 3: Doctor’s Orders
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