Aside from money that you have for your monthly expenses and some discretionary expenses the money you should have in your bank is money for an emergency. This money should be treated differently to the other money you have that is for your expected expenses and your goals.
2 popular questions are
- How Much Do I Need?
There are different opinions about how much this should be. Some say 3 months of your normal monthly spend and others say 6 months of this. This means that if you spend 4000 per months you should have 12 000 in the fund if you choose the 3 month option. And if you choose the 6 month option then you should have 24 000 in the fund.
These are high amounts and you are right to think so especially if you are in secure employment and being laid off is not a worry. However, if you are self-employed or in a career that has a high turnover the scenario will be different and an emergency fund is a good idea.
Even if you have a steady career or regardless how other goals are building an emergency fund should be at the top of your priorities. It is more than wise to have some money that you can get to in an emergency.
- Where Should I Keep It?
I already have my money in a bank account you may be saying. Why should I not put my emergency money in the same account? Why should I open a different account? Well this is because your emergency fund money should be put into a high interest bearing account.
To get a little more interest you should open a Term Deposit Account. A term deposit account means that you separate the money from your normal saving and it is locked in for the term you choose; 3, 6 or 12 months. The interest rate will be higher to compensate you for agreeing to leave your money in the bank until the maturity date when the bank will return your money plus interest. If interest rates fall during this holding period, you are protected and will likely get a better rate of return than you would have gotten in a normal savings account.
Pick terms that you can live with. If nothing happens to warrant taking money out ask the bank to start a new term. You can take out the interest or return the full amount. You can also split your money into several deposits with different time horizons. This way you will always have some money available in the near future, instead of locking all of it up for one year.
Ask your bank for the minimum required amounts and the interest rates they offer for each term. Also, you do not have to keep your emergency fund in the same back as your other money. You can shop around and find the best possible interest rate and service.