Experts recommend that you have an emergency fund sufficient to cover three-to-six months of living expenses. Your emergency fund should be a safe, stable reserve such as a savings account or money market fund. If you are new to the workforce, it may take time to build up an adequate reserve. The easiest way is to transfer a portion of your paycheck every pay period directly into an account. If you dip into your emergency fund, replenish it as soon as possible.
In addition to an emergency reserve, you need to think about liquidity. Liquidity is a term from economics that indicates how easily an asset can be converted to cash. Some asset classes are more liquid than others. Cash and money market funds are the most liquid assets. Stocks and bonds are usually liquid. During periods of financial turmoil, however, you may not want to convert these assets to cash as values will likely be depressed. In these situations, people may be forced to sell what they can, rather than what they should, which can depress values further. You should also consider the liquidity of your accounts. Retirement or education accounts may hold liquid assets, but the accounts themselves have withdrawal restrictions and penalties and are therefore less liquid.
During a period of widespread economic dislocation, illiquidity plays a significant role, which in turn has an impact on both Wall Street and Main Street. In good times or bad, all of us need to maintain an adequate emergency reserve and fully understand the overall liquidity of our assets.
