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Everybody talks about how to build an emergency fund, but I have designed the best emergency fund ever. That’s right, you need not read any more on this topic after you finish this post because my idea is PERFECT. Your welcome.

I recently wrote about how I didn’t feel that an emergency fund was important when I was getting out of debt. That’s because I had enough positive cash flow each month to handle most emergencies, up to $2,000. Instead of setting aside cash, I planned to pay for unexpected expenses out of my paycheck.

When you have an emergency fund it might help you for one month when you are in debt, but if you spend it you will just have to cut your debt payments the next month to build it up anyway, so what’s the point?

But now that I’m out of debt and facing the prospect of a career change for next year, I think it’s important to save up six months of expenses in case of unemployment or underemployment.

My plan is to save $10K By New Year’s Day. I came up with this number by following my Job Loss Emergency Plan (read it here if you haven’t had a chance). It’s a nice round number that I feel will allow us to survive six months of unemployment, with some sensible cutbacks.


The BEST Emergency Fund Ever

A lot of dispensers of personal finance advice tell you that you need an emergency fund, but don’t tell you how to set it up.

Because I’m building one now, I’m going to share with you how to set one up.

The emergency fund I’m designing has four layers, each a bit harder to access. All four layers consist of cold, hard cash. That’s because you shouldn’t have your emergency fund in anything other than cash. Not in a mutual fund or brokerage account. Just cash.

In addition to keeping it in cash, you should also pretend it doesn't exist when it comes to calculating your asset allocation. For example, I will probably save for retirement using the permanent portfolio (25% of assets in each category of stocks, bonds, gold/silver bullion and cash). I will not be counting this $10,000 cash as part of my allocation plan, though it will figure into my net worth.


Layer 1 – Cash at Home

It’s important to keep cash at home, but not too much (in case of fire, theft, spending impulses, etc).

A good amount to keep at home is $1,000.

This amount should be enough to cover the immediate needs of most families (whether it’s bailing your drunken spouse out of jail at 3 in the morning or paying that scary looking locksmith who only takes cash).

A thousand dollars is a suitable amount, but not enough to elicit much worry of loss due to fire or theft (invest in a good, heavy fire safe that can be bolted to the floor).

If you are afraid to keep cash at home, get over it.

If there is some type of natural disaster that shuts power off to your bank and ATMs, you won’t be able to use your credit or debit card at the store to get emergency supplies like food and fuel for your car or generator. If they are open and running on generators, it is almost a certainty that they will be accepting cash only.


Layer 2 – Cash in Your Linked Savings Account

What is a linked savings account? It’s just a savings account with the bank that holds your checking account. You should be enrolled in online banking so that you can link the accounts together and easily transfer money between them.

For my setup, I will be keeping $2,000 in this account.

Having a linked savings account is useful in case you need to write a big check or make an unexpected payment from your checking account. Having them linked means that you don’t have to wait for transactions to clear. Once you transfer already-cleared funds between them, the balance change is immediate.

This is useful if you make an error when balancing your checkbook and realize that you have less money in your checking account than outstanding checking payments. A quick transfer from any instant access savings account to checking can fix this error until your next payday, when the money is replaced.

Having it in your savings account also means that you can access it at an ATM no matter where you are, though daily withdrawal limits may inhibit how much you can access. Check with your bank in advance to find out your limit.


Layer 3 – Cash in an Online Savings Account

These days online savings accounts are pretty common, and often offer the best interest rates.

I will be putting $3,000 in my online savings account at SmartyPig.

An online savings account is used because this is the hardest of all to get money from. It requires me to log in and transfer it back to my checking account, a process that takes a few days.

Make sure you choose one through a reputable bank, and one that has a good interest rate.


Layer 4 – Cash in a Safe Deposit Box in Another Town

A safe deposit box is a locked and secure box (usually at a bank or financial institution), that is accessible during normal bank hours.

It is useful for storing cash, jewelry, important papers, bullion, collectibles, and more.

By having it in another town, it is harder for you to access, which makes it less likely that you will get into your emergency fund cash on a whim. This also means that if there is some type of natural disaster in your hometown, one where the power is out indefinitely, there is a good chance that the other town you’ve chosen (if far enough away) still has power, allowing you to access your money.

My parents live about an hour and a half from me, near where I grew up. I plan to open a safe deposit box there, put in $4,000 in cash, and hopefully (if the bank allows), also grant access to my parents in case I am incapacitated.


Diversified, Accessible, Tiered, Separate, All Cash and Forgettable

Using my $10,000, you can see I've broken it up this way: $1,000 (Layer 1) + $2,000 (Layer 2) + $3,000 (Layer 3) + $4,000 (Layer 4) = $10,000.

If you want a $20,000 emergency fund or don’t like the way I've allocated the money, feel free to change the numbers up.

Just keep in mind that the BEST emergency fund is one that is set up in tiers, each harder to access than the others. It is also diversified, meaning your cash is spread out in multiple locations in case of calamity. It is also cash-only, so don’t put it in your Roth IRA.

Most importantly, it is separate from your other assets and asset allocations plan. The best emergency fund is one that you forget is there.