One of the most important characteristics of a wealthy person is that he or she saves for the unexpected. You will have a time in your life when something goes wrong. Your car’s alternator breaks, the water heater in your house needs replacement, or you break your arm and your health insurance carries a high deductible. These are all incidents that we cannot predict. We can budget for car repairs and health insurance deductibles, but some accidents are impossible to foresee. When credit cards started to become more popular, you might have heard people say that they carry a credit card for emergencies. While I understand that some situations make credit cards a convenient way to get yourself out of a jam, I don’t think it’s wise to rely on credit for emergencies. Having said that, if you carry a credit card for emergencies, but you carry an emergency fund in a separate savings account, then there is nothing wrong with that. You would simply pay the credit card bill with that emergency fund. But, if you are living paycheck to paycheck with absolutely no cash cushion, life’s little emergencies will quickly send you into credit card debt that is out of your control.
The first step of the book The Total Money Makeover by Dave Ramsey is save up at least $1,000 in the bank before you start paying off debt. The reason is that he knows that the unexpected will occur, and this will help prevent you from getting into more debt while you’re trying to pay it off. In my 5 step process for getting and staying out of debt, I employ this step as well. The last step to my getting and staying out of debt plan is saving up a large emergency fund. The only way to STAY out of debt is building up a large cash emergency fund.
How much money do I need in my emergency fund?
Typically, the rule of thumb is 3 to 6 months of household expenses. All you need to do is total up all of your monthly bills, including what you spend on groceries, gas, and household products. If that total is $3000, then a very conservative emergency fund would be $18,000. A more liberal fund would be $9,000. I think that every family’s situation is different. If you feel that more than six months of expenses is necessary, then go ahead and save a little more. If you own a house, make sure your emergency fund is fairly high, because an air conditioner that breaks can be quite expensive.
Where should I park this emergency fund money?
I think the best place to put this money is a high-yield money market account or online savings account. Online savings accounts such as Emigrant Direct and HSBC direct offer savings rates of 5 percent! These online savings accounts do take about 2 days of processing to get the money into your checking account, so that is why it’s good sometimes to keep a credit card just in case you need to pay for something right away. Then, you can just transfer the money over from your savings account and pay the credit card bill.