Creating an Emergency Fund often slips our mind, only to resurface when it’s too late. Some resort to funding their emergency with a credit card, while others borrow. There are many ways to fund an emergency but they can become costly if you are not prepared. Why do we need an Emergency Fund? Here are a couple of examples that you may not have considered (I sure didn’t):
When I was 18 years old and I moved out of my parents’ house, I had car insurance and it had a standard $500.00 deductible. Having insurance is good, but in hindsight I have no idea where the $500.00 for the deductible would have come from if I actually got into an accident. Or how about another big expense? By the time I was twenty, I felt the pinch. The transmission in my truck went out. The cost of the repair was $1,200 and I didn’t have it.
Fortunately I had parent’s who cared for me and helped me out. But I often think, what would’ve happened if my parents were unable to help me? Where would I have gone for that money?
Of course, there are options; one of which is applying for a payday loan. Scary thing is, these loans can have very high interest rates. Fortunately for Military readers there is a law that caps the maximum interest rate at 36%[1]. Read the Consumer alert on Payday Loans here. An alternative route that people take is to finance their emergency needs on a credit card, which is another bad idea. With the way credit cards and payments are structured, you may find yourself paying for that emergency for years and by the time it is paid off, you will have paid double because of the interest. Personally, I do not like paying double for anything! Nobody expects the worst to actually happen, but it’s still very important to plan for an emergency.
And it’s not just a matter of my personal opinion. Check out MSN Money. They have great articles on creating an Emergency Fund. The Financial Bloggers Network, Suzy Orman, and Dave Ramsey also all address the need for one. And Dave Ramsey lists an Emergency Fund as a priority item for both getting out of debt and for financial peace. And the first “Baby Step” he states is to save $1,000.00.
On that note, let’s address how much an emergency fund should be. Most financial guru’s recommend you save three to six months worth of expenses. Three months should be the minimum if you are single and six months if you have dependents (wife, children). When I first started to learn about personal finance, I said to myself “How will I save three months worth of expenses?? This is going to take forever…”
I’ll admit my emergency fund has taken a significant amount of time to grow, but it’s been exciting to watch. And no, I’m not trying to be the poster child for David Ramsey’s method, but I am an advocate of it. My personal experience followed Dave Ramsey’s “Baby Step #1: Save $1,000 FAST!” I decided to set mile markers for myself. My first goal was to pay myself first. This is a very important concept, since most people pay all the bills when they receive their paycheck and by the time the bills are paid they have nothing left to save. I was in this same rut. But you quickly learn how great it is to “Save first, Pay later!”
There have been a few times where my phone bill was over budget. I simply carried the remaining balance over to the next month and cut back my phone usage. Instead of stealing from my savings to pay the balance, I’m continuing to save towards my goal and effectively “stealing” from the phone company. My mother calls it robbing Peter to pay Paul. I call it robbing major corporations to pay myself!
By doing this, the first month I saved $125. And by the next pay check, I saved $75. Then I received a bonus and after taxes was able to place it entirely in my emergency fund. Before I knew it I had saved up the $1,000.
I know people may see this as a cheesy success story, but it’s really easy. Just set small steps for yourself. If you can only spare an extra $50 a month, then do it. It’s better than saving nothing! Set the goal to save $50 per month until you’ve reached $1,000. And to be honest, I’ve found that $1,000 is a good number to start with. If you consider it, that $1,000 can pay for most short-term disasters like emergency car repairs or your insurance deductible, et cetera. And once you’ve completed your first “Baby Step,” then you can begin attacking your debt.
So the question remains where should you save your money? There are many options. However, it’s truly a matter of preference. Yes, there are the obvious options like placing it in a high-yield account, et cetera. But my personal experience has led me to have my emergency savings split between two places. First, my bank allowed me to open a secondary savings account. This savings account is attached to my main account, but it is not accessible from my debit card. This is more or less to save me from myself. I’d like to avoid my inner child shouting “I WANT IT” from rationalizing an expensive purchase and uselessly draining my account. Secondly, I’ve chosen to store a portion of my money at ING’s sharebuilder.com in their default money market. ING’s Sharebuilder will store your money in a money market account that has a competitive interest rate and it doesn’t charge any fees for transfers. There are also no obligations or minimum amounts, which translates into less fees.
This won’t necessarily work for everyone. Bankrate.com is a website that hosts information on current rates for large banks. Browse through the banks and their rates. Make sure you actually read all of the terms and understand them. If something looks odd, call the bank and ask before you open an account. It will save you a lot of grief in the long run.
Essential to the concept of an emergency fund is that you must be able to obtain immediate access to your money. Keep that in mind when you view your options. It also would not be wise for you to store your money in an account where you will be charged penalties for withdrawing the money early. Remember, it is an emergency account and you will need access to the money in the event of an emergency, so keep things flexible.
In closing, here are some tips from my personal experiences:
[1] http://www.ftc.gov/bcp/edu/pubs/consumer/alerts/alt060.shtm
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really enjoyed this post. I’m a huge fan of ING too.