Almost 50 percent of Americans cannot come up with $2,000 for an unexpected expense, even if they have 30 days to get the money. That’s pretty scary! Consider all the different ways someone may need to come up with cash quickly: $1,000 deductible to repair a wrecked car, 20 percent co-payment for a broken arm, or paying the rent after losing their job.
What everyone needs is an emergency fund. This is cash set aside to protect your monthly budget from being derailed by these inevitable, yet always unexpected, expenses that occur in life.
The number one reason people start the downward spiral into credit card debt is due to an unexpected expense that could only be paid for with credit. It’s usually the only option when you don’t have any cash. Once there’s a credit card balance, it’s easy to justify a new $75 shirt that won’t add much to your balance. A few more impulse purchases later, and next thing you know there’s a huge balance on your credit card at a 15 percent interest rate; and you can only afford to make the minimum payment. Credit cards can lead down a very slippery path. Use them with extreme caution.
Emergency fund basics
An emergency fund should be large enough to cover 3-6 months of living expenses. This money is held in a separate bank account so there is absolutely zero temptation to spend it on non-emergencies. Make sure to verify your bank is FDIC insured.
This money should never be invested in the stock market or any investments like CDs or bonds. I don’t care that interest rates are basically 0 percent in today’s economy. Why doesn’t anyone ever complain that their car doesn’t fly? Because a car isn’t designed to fly. So don’t grumble about your emergency fund not earning enough interest. That’s not what it’s designed to do.
The purpose of the emergency fund is safety and accessibility, not maximum return. When bad stuff happens, the emergency fund allows you to absorb those unexpected bumps and stick to your monthly budget without going into debt.
How to get started
If you currently don’t have an emergency fund or find it difficult to save money, the key is to start small. You have to realize that accumulating 3 month’s worth of expenses will take some time. If you set your immediate goals to be small and manageable, you will have a better chance to achieve them.
Begin with a small amount, maybe $10 a week initially. While this won’t add up all that quickly, the important thing is to start putting something away to make it a habit. After a month, you won’t even miss that $10, so bump it up to $20 per week. Take advantage of automatic online transfers so you don’t have to think about it.
The first step is to save $1,000 in an emergency fund. After that, focus solely on paying off credit card debt if you have it. Once all the debt is paid off, re-start the emergency fund savings until it’ll cover 3 months of living expenses.
Studies show that those without emergency funds are more likely to accumulate debt. It may feel like you can’t afford to have one, but the truth is you can’t afford not to have an emergency fund.
Steve Doster is a Certified Financial Planner™ professional, providing commission-free financial advice for do-it-yourself investors. You can reach Steve at Doster Financial Planning by phone 619-688-1192 or email steve@dosterfinancialplanning.com. You can also follow Steve on Facebook, Linked In, Twitter, or his blog dosterfinancialplanning.com
