Why do you need an emergency fund?
An emergency savings account comes to your rescue when unplanned expenses arise. The car breaks down, the roof springs a leak. These situations create a certain sense of alarm, not unlike emergency vehicles with high-pitched sirens and flashing red lights. But unplanned expenses can be handled with emergency savings -- the financial equivalent of a handy home defibrillator.
Emergency fund essentials
1. Why you need it
2. Savings guidelines
3. Getting started
In the absence of that savings, credit card or high-interest rate debt often fills the void.
"If there is one thing financially that will help you sleep better at night, it's the knowledge that you have some money in the bank for a rainy day,"
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A lot of financial difficulties can be traced back to a few common root causes, and one of these is lack of emergency savings. For that reason you need to plan for the unexpected, whether for a dental bill or job loss.
How your savings can save you
1. Your car breaks down
It always happens when you least expect it. Your car requires routine maintenance, and those costs are bad enough. But even if you give it TLC, you can count on occasional mechanical disruptions. Plan for it.
Why you need it
Up until now you may have relied on home equity or credit cards for unplanned expenses or emergencies. If you tap home equity, you generally incur more debt (at least until you sell your home). If you use credit cards, you are committing future earnings to current spending. Neither of these is a desirable financial solution. A savings account empowers you to use your own funds to meet financial challenges. And when you're not using the funds, the bank pays you interest.
Emergency fund essentials
1. Why you need it
2. Savings guidelines
3. Getting started
We suggest keeping emergency funds in a high-yielding money market or savings account so that the money generates a tangible return in the form of interest. "These types of accounts are going to get a lot more attention now," "There's finally a bit of a premium to be had on longer term investments." We suggest that once you have six months of expenses in a savings account, boost your return a little bit by taking half of that and investing in a three-month CD or a short term bond fund while keeping the other half in a liquid money market or savings account.
Check out high-yield rates with many different companies.
Savings guidelines
The rule of thumb is to save three to six months of living expenses -- more if you're self-employed or the sole breadwinner. But the key is to have a system of automatic savings that can replenish the account in case you dip into it. Although three to six months is the ideal cushion, it's going to take quite some time to get to that level.
Figure out your monthly living expenses with this work sheet. Work out how long it'll take you to get there with a simple savings calculator.
Getting started
The biggest obstacle to saving is not being in the habit of doing so. So take steps to pay yourself first. Set up direct deposit from your paycheck to a high-yield savings or money market account. This accomplishes two things, It works toward building a savings cushion and forces you to live on less than you make.
"Those are really two key steps on the road to financial security: saving regularly and living within your means,"
Why do you need an emergency fund?
Even in the presence of debt, contributing to an emergency savings account takes top priority, but not at the exclusion of working toward other goals. "It's the habit of regular saving that has to be instilled, even if it's $25," "The money you get from trimming expenses or working a second job can be used for aggressively paying down credit card debt."
Follow these steps:
1. Establish the habit of saving through direct deposit to a savings account, and at the same time sign up for the company 401(k) plan.
2. Tighten your budget to pay down credit card debt. Use the budget work sheet.
3. Use a debt pay-down calculator to get debt off your balance sheet.
4. Figure out how quickly you can amass your emergency fund.
5. See how your savings can grow.
A benefit of working toward multiple goals simultaneously is that if you're building savings while paying down credit cards, you have some savings in place that should absorb an unexpected expense. This reinforces the need to have that savings and doesn't negate your debt repayment efforts.
For handling the larger expected bills looming on the horizon -- say, property taxes -- you have a few equally good choices.
Select the plan you prefer:
• Include extra savings to your emergency savings account.
• Create a separate side savings account with the express purpose of meeting your tax bill.
• Incorporate the added savings into your regular monthly budget so that while you may only pay taxes or insurance once a year, you are effectively breaking the bill into 12 smaller chunks.
Where the money lives is up to you. Whether you keep it in a checking account so you can just write a check when the bill comes due or move the money to a high yield account for the interim, the discipline is to set that money aside so it's there when you need it.
"In the end,", "there's no substitute for good, old-fashioned discipline. That emergency savings account isn't something to tap for pizza on Friday night."