One of the smartest things you can do when things are going well is to establish an emergency fund as part of your savings plan. You should aim to set aside enough money to cover three to six months of living expenses or perhaps even more. That way, if an unforeseen event puts a drain on your finances, you’ll have some back-up funds to help see you through.
Ideally, your emergency fund should be fairly liquid, which means the account value is available as cash or can be converted to cash easily with little or no loss of value. But the money you’ve put aside for emergencies should also produce some return, or increase in value, to help ensure it doesn’t lose purchasing power. Certificates of deposit (CDs) and money market accounts may fit your needs. So may US Treasury bills, which you can buy online with a TreasuryDirect account linked to your bank account.
For example, you might create a ladder with three 12-month CDs of equal value that mature on a rolling basis during the year—say in February, July, and October. If you need cash in an emergency, you can liquidate one of the CDs as it matures rather than rolling it over and extending the ladder with another CD.
What’s not smart is putting your emergency money in a checking account. While the account is liquid, having extra cash so accessible makes it too easy to spend on mini-emergencies or even everyday expenses.