The Importance of an Emergency Fund
We’ve all seen that bumper sticker, right? S*%T HAPPENS. It might be a crude way to put it, but it’s absolutely true. Unfortunately, when stuff happens, it tends to hit us in the pocket. It could be as minor as a speeding ticket or as major as losing a job.
There are things we can do to be ready when the unexpected happens and make sure that when it does, we can suffer the blows and be back on our feet ready for action before the ten-count ends. One of the best things you can do is establish an Emergency Fund.
What exactly is an Emergency Fund? It is proof that you have disembarked from the ship of Denial. It’s a major method of protecting yourself from loss.
How much should be in an Emergency Fund? There is no magic number that everyone should shoot for in their Emergency Fund – the number will be different for different families or individuals. So, how do you know if you have enough? Wise financial advisors recommend having at least 3 to 6 months of living expenses PLUS enough to pay all of your insurance deductibles at once.
This recommendation is based on the Worst Case Scenario methodology. I’ll use an example that may ring true to those of you fearless readers that weathered out the 2004 Hurricane season here in Florida. Say that a major storm targets us again and it damages your place of business beyond repair. Now you have no place to work; you are laid off by a very sympathetic but realistic boss. Imagine that the same storm that blew away your steady income also blew over a tree in your yard that just happened to fall on your garage – damaging your home and the car residing therein. Before that friendly insurance company that you’ve been paying hefty premiums to will even begin to repair this damage, they demand you pay your deductible. Talk about adding insult to injury!
If you had already followed this sage financial advice, you would be able to pay those deductibles without emptying out all existing bank accounts, running up the credit cards and borrowing from every family member who would answer their phone. Plus, you would be experiencing much less stress than your neighbors because you already know that the next 3 to 6 months of household expenses are covered leaving you the relaxed freedom to search diligently for your next steady stream of income – a new job.
How do you know what a month’s worth of living expenses is? You need to sit down with pen and paper, add together how much you pay for: rent/mortgage, utilities, cable, phone(s), auto insurance, car payment, credit card bills, medical bills, etc. Those are your fixed expenses - items that you are contractually obligated to pay or must pay in order to maintain the roof over your head and the lights to see by. Add to that, your estimated costs for gas and groceries for the month. Once you have this big dollar figure, multiply it by three to get the minimum amount to shoot for in your Emergency Fund. That way you know that if the worst were to happen, you could stay current with your main expenses for at least three months. Planning for six months is ideal, but at least three months is necessary.
Take note: this Emergency Fund calculation does NOT include money for dining out, ordering pizza, renting movies, giving gifts, buying clothes and other fun stuff. Most of those things will have to be put on hold until you have a steady income again. Difficult times call for difficult measures.
Where do you keep this Emergency Fund? In a safe place! No, that doesn’t mean in an envelope under the mattress. I suggest keeping these funds in a high yield savings account separate from your other accounts, maybe even in a whole different bank. Some place you can earn interest, be ensured that your money is FDIC or NCUA protected, and is perhaps just a bit difficult to get to. If it’s too easy to get to, it’ll be too easy to take from in a pinch.
When should you start your Emergency Fund? NOW! Start small if you have to, but just start it! Perhaps your employer provides direct deposit. If so, arrange for maybe $10 or $20 a paycheck to be directed into this separate savings account. If you don’t have the option of direct deposit, you’re going to have to exercise a little more self-control and physically deposit those funds consistently in the appropriate account. If you can afford more - even better, but don’t overburden yourself unnecessarily. There are too many necessary burdens in life to do that!
How do you know how much to start with? You'll need to know where in your budget you can make room for this Emergency Fund expense. If you haven't already developed a simple spending plan, also known as a budget, you might consider attending a free 1-hour workshop designed to help you do just that. Its offered twice a month at the Fort Pierce downtown library.
Lastly, there are additional bonuses of an Emergency Fund: (1) having cash available to pay higher insurance deductibles allows you to save money on your auto insurance. Opting for lower, more affordable deductibles equals higher insurance premiums but a necessary evil if you don't have the resources to pay a higher deductible. (2) once you get to your target amount, you can then use that same ‘extra’ money to focus on making the money you don’t spend - work for you!
