Grandma always had a rainy-day fund. No matter what emergencies came along, she always had the means to solve the problem; not only hers, but a few of mine as well. You can't get away from emergencies. Companies are closing, people are being laid off that thought they had secure jobs, courts are dissolving retirement plans, transmissions go out, there are surprise pregnancies, loved ones die or the grown kids move back in. You never know what life will throw at you.
You need an umbrella to handle those rainy days or all of your hard work at budgeting will be turned into chaos. You need build a starter emergency fund of $1,000 as soon as possible. It may not catch the big problems, but it will allow you to solve ninety percent of the problems that pop up so you can stay on budget. You can handle the emergency without stopping your whole financial fitness program and you will find that emergencies really aren't emergencies anymore when you have the means to take of them.
A lot of people say they need to have a credit card to take care of emergencies. Don't fall for that rationalization. It simply means that you don't have the discipline to create an emergency fund. The other big rationalization people use is defining what an emergency is. Christmas is not an emergency. It is on the calendar every year. Car maintenance and your children's school clothes are not emergencies. They belong in your budget. A great sale on a new dining room table is not an emergency. When you save up the cash to buy one, you will be able to negotiate an even better bargain.
Actual emergencies are things we normally can't budget for, such as suddenly getting laid off from your job, the muffler fell off the car or the compressor in the refrigerator broke. So, you need to do whatever it takes to start your little fund. Work a second job for awhile, work some overtime or sell some stuff you don't ever use. Be creative, but do it. The Jones and your family may think you've gone crazy, but you will have the last laugh.
So where do you keep your emergency fund? You need to put it someplace liquid where you can get to it almost immediately. This is not an investment fund. It should not be put into a Certificate of Deposit or anything that charges a fee for early withdrawal. That way you can't use the excuse that you don't want to take it out, because you'll lose money and so you use credit instead.
Personally, I went to one of the local credit unions and opened a new checking account with an attached overdraft regular savings account, and one of their high-interest savings accounts. The emergency fund goes into the high-interest account and my Christmas fund goes into the regular savings account. The money for the regular household budget is in another bank entirely. If I feel that I really need something outside the budget that is not an emergency, I can always write a check from the credit union and if there is not enough in the checking account, it overdrafts if from my regular savings. Now, I know that I will have less to spend during the holidays, but it doesn't affect my budget or financial freedom plan.
On the other hand, I can't just write a check from my emergency fund. I have to go through the extra step of going online, into a bank branch, or ATM to transfer the money from the high-interest account to the checking account so that it can used. I can quickly get to the money if I need it, but because of the extra step involved, it makes sure that I determine if it really is for an emergency. If you keep it in the sock drawer, it is too easy to give it to the pizza man.
Remember, if you are running a small business, you also need to have a separate emergency fund. Equipment breaks and accidents happen. Finally, if you DO use money from your emergency fund, then you need to cut any other expenses back to minimum payments until it is replenished. You never know when the next lightning bolt will hit.