How to create an emergency fund

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Lending money to family members can be a delicate situation
Having money set aside for difficult times can help you achieve the stability you need to pursue financial goals.
From the Merrill Edge Minute e-newsletter.
An emergency fund can help you meet daily expenses when you're facing job loss, lowered earnings from investments or an unexpected expense. It can also help you avoid tapping long-term investments, which can have a significant impact on your ability to meet future needs. Consider following these tips to simplify the process of building an emergency fund that can offer you a sense of confidence and help keep your financial goals on track.
  • Calculate how much you may need. An emergency fund should be large enough to cover at least six months of living expenses. Base it on an honest account of monthly and other predictable expenses, such as upcoming home repairs.
  • Keep short-term cash risk-free and accessible. Put at least the first three months' worth of savings in an interest-bearing, federally insured checking account or money market savings, so that it's essentially cash with no withdrawal penalty. The goal is to have limited risk associated with this portion of your money and always to have the funds available. For money that you won't need right away, look at building a "ladder" of short-term certificates of deposit or bonds. You can do this by buying individual CDs or bonds with staggered maturity dates.
  • Build your emergency fund slowly. Pay attention to your cash flow needs when setting aside funds. Putting a huge lump sum into an emergency account isn't useful if you'll need to take the money out again to pay for necessities such as housing or utilities. Instead of committing large sums all at once and affecting your cash flow, build your emergency fund methodically. Contribute small amounts consistently, setting aside extra change or bills at the end of each day, or using funds freed up as debts are paid.
  • Put your emergency fund deposits on autopilot. It can be easier — and help you save more consistently — to set up an automatic transfer from your Bank of America checking account to your savings account.1 Or, if you have direct deposit, you may be able to set up a specified amount to be automatically directed from your paycheck to your savings account.
  • To keep your strategy on track, avoid a sense of deprivation. The basic principles of behavioral finance tell us that if your financial strategy leaves you unable to indulge wants such as the occasional dinner out, the resulting sense of deprivation can backfire, leading to unwise expenditures. Instead, try to balance your strategy, setting aside money for an emergency fund and other long-term goals, as well as some to reward yourself.
  • Pay down debt and build up your emergency fund. If you have debt with a high interest rate but focus only on saving money in a low-interest account, you're going to wind up at a net loss. But if you spend all excess cash on paying down debt, you aren't likely to accumulate enough of an emergency fund to tide you over in times of trouble. Of the additional cash you have, consider using half to pay down your highest-interest debt and put the other half into an emergency fund. Then when your debt is paid off, add that extra amount to your emergency fund savings.
  • Don't overfill your emergency fund Monitor your emergency fund to see how much you've accumulated, and keep an eye on your living expenses to see whether they've changed in a way that would affect your saving goals. Once you've reached your target number for your emergency fund, consider reallocating extra cash to investments that pursue growth.2
Next steps

1 Please keep in mind that an automatic investment plan does not ensure a profit or protect against loss in declining markets. Such a plan involves continuous investment in securities regardless of fluctuating price levels. Investors should carefully consider their financial ability to continue their purchases through periods of fluctuating price levels.

2 Please keep in mind that investing involves risk. There is always the potential of losing money when you invest in securities.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.