If your car blows up next week, do you have enough money to get back on the road without using a credit card? If you lost your job tomorrow, do you know how you’ll pay for your bills next month?
Money Magazine says that 78 percent of us will have a major negative event happen in any given 10-year period of time. Just 38 percent of Americans said they could cover an unexpected emergency room visit or even a $500 car repair with cash on hand in a checking or savings account, according to Bankrate, which commissioned the study. When I take a quick look at my life, I have lost my job twice in the past two years. The first time I lost my job, we weren’t even close to being prepared. We had just purchased a home and used up all of our savings account for the down payment. We had to turn quickly to using our credit cards to make ends meet. We had been debt free for nearly a year when it happened and we saw our credit card debt jump quickly up to more than $3,000.
So what can you do to soften the blow when an emergency comes up? The answer is pretty simple, you need an Emergency Fund. Sometimes we call this a rainy-day fund. We know it is going to rain, life happens, so you need to be ready. The emergency fund is an important component to your financial plan.
What is an emergency? I would venture to say that most of us use credit cards to catch all of our “life emergencies” that pop up in our lives. I think Dave Ramsey says it best,
Some of these so-called emergencies are events like Christmas. Christmas is not an emergency; it doesn’t sneak up on you. Christmas is always in December, they don’t move it; therefore it is not an emergency.
If your transmission goes out on your car and needs repairs, or your family decides to go on a last minute vacation; These are NOT emergencies; but they are items that we should be budgeting for. We as Americans use our credit cards for real emergencies too. An emergency is a job loss, an unexpected pregnancy, illness or having to bury a loved one, are all reasons for an emergency fund to be set up. One thing is for sure, we need to break the vicious cycle of our dependence on credit cards to cover our emergencies and our lack of budgeting.
So how much should we be putting into our emergency fund? How fast should we be able to get it funded? A lot of experts have different opinions on the topic of how much we should have in our emergency fund. I mentioned in my last post, How to Get Out of Debt, that April and I started by building our emergency fund up to $1,000. My recommendation is to start by funding $500 to $1,000 depending on how much money you make. If you make $25,000 or less each year, start out by funding your account to $500. If you make more than $25,000 a year, then you should start by getting your account to $1,000. This is just the beginning, as your emergency fund will not be fully funded until you have eliminated your debt. We can all agree that everyone needs an emergency fund to be prepared for any contingency. The Bureau of Labor Statistics has stated that more than 5.5 million Americans are unemployed for 27 weeks or longer. So our ultimate goal will be to fully fund our account at three to six months (we will discuss the fully funded emergency fund later).
As mentioned before, the emergency fund is for just that: emergencies. Not for family vacations or for buying new toys. There is no cheating here! The idea is to build up your beginning fund as fast as possible so you can start working on getting out of debt as soon as possible. Sit down and really set up a budget, work extra hours if you can, sell your baseball cards, have a garage sale, but get to $1,000 fast. It took April and I just over a month to get our emergency fund to $1,000. When you sit down to set up your budget, if you find that it is going to take much longer than that, then you have to start looking at doing something crazy. I am not saying that you need to do something illegal here, but sell plasma or deliver pizzas. Then, if a REAL emergency comes up, you can use your emergency fund and not your credit cards. No more adding to your debt, you have to snap this vicious cycle now!
A lot of my friends and clients that have worked with me through setting up a budget and their beginner emergency fund have asked where should they put their money? I have told them, and I will tell you the same thing, keep it as liquid as possible. That doesn’t mean that you are going to keep it at home, otherwise you would be tempted to spend it. We put ours in a Savings Account at the bank. I wasn’t going for high interest rates, just a place that I could keep it and get access if I needed it. And I was glad that I did! It wasn’t but a month or two after we had it fully funded that I had some serious car trouble come up and it was going to cost more than $600. I would have normally just put it on the credit card, but I just ran over to the bank and withdrew the exact amount I needed, nothing more.
Now that brings me to the next commonly asked question. What if I need to use some of my emergency fund? And should I keep paying off my debt? The answer is simple, stop the debt reduction process and build your emergency fund until the full $1,000 is restored.
I am very passionate about this step, because I have seen it be successful for me, and have seen myself fail because I didn’t restore my emergency fund for when I had really needed it. I have seen a lot of my family, friends and clients be successful in doing this process, and I know that you will too. Don’t make up any excuses or rationalize a way out of doing it. Get started today and you will feel much better when the situation comes knocking on your door.
Question: What are some of the crazy ways you have earned money to reach your emergency fund goals? You can leave a comment by clicking here.