Saturday, September 13, 2008

Short Term Bucket: Building a Safety Fund for “Rainy Days”

Your Short Term Fund is the first place you should put your extra money after you have paid all your expenses.

The time horizon for a short term fund varies widely depending on who is giving the advice, but in my opinion this fund must contain enough money to live comfortably for six months without working (in the event you get laid off), plus money for medium to large expenses you plan to incur in the next five years: a down payment for a house or a new car, a trip you want to take, a wedding, a new roof, car repairs, etc.

Let’s say that you need $3,000 per month for living expenses, plus you will buy a new car in two years and need to save for the down payment. You may also need to fix your roof or want to take a trip to Europe. These are all short term expenses. You will need to save 6 x $3K = $18K for six months living expenses plus all your other short term expenses.

Other than the six months living expenses, which you must try to accumulate as soon as possible, you can set up a savings schedule for other expenses depending on when do you expect them to happen.

Since this is money that you will need in the short term, it shouldn’t be invested in risky, long term vehicles like stocks or mutual funds. The best options are:
  • Savings Accounts: Internet savings accounts (like ING or Emigrant direct) usually pay better than regular bank savings accounts.

  • CDs (certificates of deposit): these pay better than savings accounts but they tie your money for a specific period of time (3, 6, 12 months or more). One thing you can do to mitigate this is to invest your short term fund in different CDs, with different maturity dates, so all the money is not tied up at the same time.

  • Money Market Deposit Accounts: These accounts offer a rate close to that of regular savings accounts but limit the amount of transactions you can make in any given month.
You can read more about Short Term Savings by following these links:

60 second guide to short term savings

High yield savings accounts for short term savings

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