Get Financially Fit in 2010: Build Up Your Emergency Fund
by Erik Folgate
Filed under Financial Advice, Personal Finance, Planning
Once you’ve gotten out of debt, the only way to stay out of debt is to have a cash reserve. I know, what a concept, actually HAVE cash to pay for stuff. We live in a society that has indoctrinated us to swipe a credit card and pay later. It’s the American way of life, buy now and pay later. Well, no one tells you that during that time between when you buy and pay later, life happens and you end up not paying later. That is the essence of the perpetual debt cycle. If you want to stay in debt the rest of your life, then spend everything you make every month and never have a cash reserve. But, if you are sick of that way of life like I am, then you must have a huge, hairy emergency fund to bail you out of life.
I know, you’ve read hundreds of articles on every personal finance blog about the importance of having an emergency fund and you’re tired of reading about it. But, have you finished your emergency fund yet? Yeah, I didn’t think so. I’m not coming down on you, because I am still in the debt repayment process. Starting and finishing a big emergency fund is a huge task, so don’t brush it off as necessary personal finance jargon. Sticking with the physical fitness theme, developing healthy eating habits and a regular exercise routine is essential to keeping weight off once you lose it. It’s not nearly as tough to lose weight as it is to keep it off for a long period of time. With debt, it’s not nearly as hard to pay it off as it is to stay out of debt the rest of your life. Life happens and the next thing you know, you don’t have enough money to cover your homeowner’s insurance deductible or car repair. A large emergency fund that you never touch except for true emergencies will prevent you from falling back into the debt cycle.
How Much Should I Put Away?
Three to six months of expenses is the rule of thumb, but I always lean more towards the six months side. Notice that it’s expenses, not monthly income. So, figure out how much it costs for you to take care of your basic necessities and multiple that by three to six. Here are some other good tips on building an emergency fund.
Where should I park my emergency fund?
The goal isn’t to get rich off of your emergency fund. Don’t stick it in a growth stock mutual fund. Put it in a high-yield online savings account. Back in 2005, online savings accoutns were boasting 4 and 5% returns, but now they are more like 2 percent. I used to recommend parking the money in an online savings account, but the problem is that you don’t have instant access to the money if you need it. What if you need to pay for a car repair right away, you cut up all of your credit cards, and you need to wait two days for the money to transfer to your checking account? My suggestion is to open up an online checking account like the Electric Orange Checking from ING Direct or a separate checking account with a separate debit card. The Electric Orange also offers a debit card. Having another debit card can make it extremely tempting to use for things other than emergencies. You could always keep it in your house and only carry it when you’re out of town.
What’s a True Emergency?
- Unexpected car repair like the water hose or radiator busting. Simply replacing old tires or fixing the brakes is not an emergency. Those should be expenses that you save for in a car maintenance fund
- Health emergency that requires you to pay a large co-pay or deductible
- A claim on your car or house that requires you to pay a large deductible
- A death in the family.
- Unexpected flight or travel expenses for a family emergency
- Unexpected house repairs. Again, you should always prepare for house maintenance costs, but some repairs are unexpected and require you to dip into the emergency fund.
So, have I convinced you yet? Have a cool story about how your emergency fund bailed you out when you needed it most? Have a story about how you wish you had an emergency fund when you had an emergency? Let us know in the comment section!
Sometimes the old-fashioned way – save, not spend – is best. We have always lived well under our means and have had no problems meeting emergency financial situations that crop up from time to time. I also lean toward having money to cover six months of expenses (or more) set aside. When was the last time all your monthly expenses went down?
I’m going the Dave Ramsey way- $1000 in an emergency fund and everything else goes to debt.
I keep mine in an ING savings account, and have opened an Orange Checking account so that I can get the money out quick with the debit card if need since the transfers are immediate within ING. Also, by opening an orange account I was able to get an account bonus.
Last year my husbands car ‘died’ unexpectedly. Although we were not happy to purchase a car before we thought we would need to, we were able to buy another car with the cash that we had saved in our emergency fund–NO CAR PAYMENT!
While Dave Ramsey’s recommendation of building up an emergency fund first is echoed by many, and is sound advice, I believe that his initial maximum of $1000 is too low. Take Gina’s example above, for instance. If she had only saved $1000, purchasing a replacement car – even a used one – would have been very difficult to impossible with only $1000.
My initial Emergency fund goal is $5000, and I think I’ve got a good start; in less than 6 months, via cutting back on spending and selling a number of things (on eBay, Amazon and Craigslist), I have been able to save 50% of my goal. After I reach $5000, I will throttle back the money going to it and funnel that money towards debt (of which we have no CC debt, so we are lucky there). However, I won’t cut off my contributions to my E-Fund entirely. I will keep it on life support with a small, automatic contribution each month and let it build; the bigger the cushion, the softer the landing.
Why $5000? In looking at the emergencies that might befall me and my family, I have found that $5000 would be the minimum to cover the most costly one – meaning our deductible from our health insurance; after that our health insurance would cover the rest. Or we could replace all of our most important appliances – furnace, water heater, refrigerator, etc. – or purchase a reliable used car if need be with $5000. Or it could also be used to cover 4 months of mortgage should one of us lose our job. To me, beyond the necessities – food, water, utilities, etc – health, shelter (including heat and hot water), and transportation are the most important items and should be the focus of the emergency fund. Everything else – cable, internet, TV, cell phone, etc, etc – can be dropped if needed.
I would recommend looking at these main items and figuring what the minimum would be to cover the most expensive one and set your emergency fund initial target to that. Once you have reached your goal, continue to contribute to it with a small amount each month – thereby building a greater safety net – and a breath a sigh of relief knowing that the worst is covered.
I totally agree and feel confident that our emergency fund is there for us. However, I really struggle with that amount of money just sitting there earning minimal interest in our online savings account. I wish there were a better option that still makes the money accessible relatively quickly.
We had a month’s worth of expenses saved in an emergency fund; I, the only wage earner, lost my job in May and didn’t find another one until August. Our emergency fund allowed us to keep our home this summer. Unfortunately, now comes the struggle to replenish it… it’s only got $50 in it now.
My father drilled in an Emergency fund since I left home. I used to think he was over-cautious, but I have thanked him so many times since. Its a must for me now
You have to pay yourself first and adjust your cost of living accordingly. Do you really need a cell phone and a home phone? What about telecommuting one or two days a week to save on travel costs?
There are ways that you can cut back without depriving yourself. My husband and I have experimented with every frugal tip that we have run across. In fact, I have so much knowledge now that I plan to write a book on the subject.
I do my emergency fund a little bit differently. I have $1000 in a savings account linked to my checking that earns interest at a pretty low rate. The rest of my emergency fund sits in my Roth IRA. I can withdraw my contributions at any time without penalty and the last time I withdrew money I had the check in my mailbox the next day…faster than a high interest savings account.
I invest my emergency fund in my Roth for a couple reasons. First, I have better returns there. Second, it’s way too easy for me to “borrow” money from my EF if its easy to access. However, since I pay a nominal fee to invest my contributions, you better believe I’m not going to touch that money for anything shy of a real emergency.
I realize that I can lose my EF in the stock market, but I always keep some of my investments in pretty low risk mutual funds. I didn’t lose every last cent in the last market downturn and doubt I ever will.
I have a question for all of you who have reached your initial emergency savings goal. How did it take you to reach your initial goal? I’m slowly approaching my initial goal of $1000 but I always feel like I should already be there. I chose the $1000 amount because it was still a bit of a stretch for me but it’s doable. Once I reach the $1000 goal, I’ll set another, higher goal.
Do any of you know the difference between 403 (b) and the other account geared for educators?
On the list for this year. As well as an energy audit (we live in ontario and the government pays us to make our house energy efficient.)
We started working towards this goal in 2009 and we definitely have at least 3 months saved. I was under the impression that 6 months was a must, so it’s comforting to know we’re okay at 3 months.
I second the recommendation another person made about an ING savings account. We also have a Roth IRA.
I was really hesitant at first at the thought of having thousands of dollars sitting still in a savings account when I could otherwise be using it to invest- especially as my highest interest rate right now was 1.5% at ING. But after a few months of research (enough time to save up half of my emergency fund anyway), I was lucky enough to find a tax-free savings account offering 3% at a local bank.
This is so hard to do! With all of the job losses and living week to week and not making it on that I really wish we had done more when we had the chance. I hope that my children will learn from our mistakes and do the right thing. I try to read to them from this and some other blogs the importance of savings. One seems to be getting it, the other I am worried about. Our emergency fund was depleted when I had to go in for 3 different surgeries all in a row, and it was right when the job shut down, out of work no insurance. We will make it back, but I can’t say enough how important this is and to pass on the importance.
Thanks for sharing that story Jennifer! It’s definitely a testament to the importance of having cash on hand to pay for life’s emergencies.
The emergency fund is key. I find that you have to make it a priority and after using the fund. It is important to reevaluate your finances and rebuild that fund. This is hard because you may not be in a great situation but that is your pillow to catch you when you fall. Make it too thin and the fall will hurt.
My emergency fund is a bit anemic right now, but I’m hoping to jump start it with a bonus that will hopefully come through. I figure if I can get it mostly funded then it doesn’t seem like such a giant task. Then I can breathe a bit and save for other “things”
I think my problem is that I don’t know when to stop! I probably have way too much money in my emergency fund, money that could be used to pay down debt or perhaps focused towards a financial goal (wedding, down payment, etc.). I did start a separate down payment fund, but I still feel like I’m being silly putting so much away.
At any rate, until I can convince myself that I have a good enough emergency fund, I’ll keep putting my automatic transfers there…and once I find a new plan, I’ll continue to automatically transfer the money to a new goal.