I am sure you’ve heard the term Emergency Fund before. What is an Emergency Fund? Who should have it? When do you start it? Where should you save it? Why do you need it? How do you start it? These are the questions that I am going to address today.
What is an Emergency Fund?
An Emergency Fund (EF) is an amount of money that you save into an account. It is to be used only for emergencies. An emergency is not buying dinner because you don’t feel like cooking. An emergency is not paying for your children’s sports activity or pictures. Emergencies might be paying for an unexpected doctor’s bill, repairing or replacing an appliance, or the loss of a job, etc.
Who should have it?
Everyone who has an income should have one. Does this include children? Yes, it does. If your children earn money from doing chores around the house, teach them about an emergency fund. Let them split their money up between giving, saving, and spending. Their savings jar should be their Emergency Fund jar. When children are taught young about saving, they develop good habits. As they get older, have them open a bank account for their savings. When they start working, they should continue to divide their money between these categories. When they have enough money built-up, have them open a mutual fund or an exchange traded fund at a discount brokerage. This money will grow for them and help them pay for college, buying a car, buying a home, and even retirement, as long as they are faithful in their savings.
When do you start it?
You start your emergency fund the moment you start receiving money. If you are working, you need to be putting money aside for emergencies. If you don’t have an emergency fund in place, when an emergency pops-up, you are going to get nailed. You are going to reach for the credit card and get deeper into debt.
Where should you save it?
You can keep it wherever you want. The key is that it must be liquid. No, this does not mean you melt down your coins or soak your bills in water. Liquidity is a financial term. It means that your money must be easy to get to, you can withdraw it without incurring a penalty, and you do have to save it for a specified time period. The best place to keep it is either in a bank or at a discount broker. Keeping the money in a bank does have some problems associated with it. Banks require a minimum amount of money in the account in order to waive their fees. Also, if you make more than four withdrawals in a month, the bank, by law, will switch your savings account into a checking account.
When you keep it at a discount broker, you should put your money in money market account. You can withdraw your money at any time, you can write as many checks as want, provided you have the funds to cover the checks. Also, you don’t have to keep it in there for a specific time period before you can withdraw the money. The other instrument you can use to keep it is a ROTH IRA, provided you qualify. A ROTH can also be used to fund your retirement account, so your EF is essentially serving a dual purpose. Be careful with this type because you cannot withdraw any of the earnings unless you are 591/2 or meet certain exceptions. However, you are able to withdraw your contributions – the money you put in.
Why do you need it?
You need an EF because emergencies happen. If you are alive, you are going to experience emergencies. Think of your EF as an offensive line in a football game and you are the quarterback. If you don’t have an O-line, the defense (emergency) is going come at you full force and sack you each and every time. If you have a weak O-line or a small EF, when a large defense player or a large emergency comes at you, you are going to get sacked. However, if you have a healthy and big O-line, a fully funded EF, when the defense/emergency comes at you, you can hold it back. You are going to be protected. You can also think of an EF as insurance for daily life expenses.
When you first start an EF, you want to put in $1,000 to start. You should do this as quickly as you can, so that you’ll have some protection. Each month you want to save some money in that fund. A fully funded EF consists of eight to twelve months of living expenses. The reason you want eight to 12 months of living expenses saved is because in today’s economy it might take you that long to find employment if you were to lose your job. A fully-funded EF gives you peace-of-mind when you are out looking for a new job.
How do you start it?
You start saving your EF by making it automatic. Take a clue from the IRS. They don’t wait for you to send them your tax payments each time you get paid. They withdraw it upfront. Do the same thing. Have the money that you have allocated for your EF automatically withdrawn from you paycheck and placed into your EF saving instrument. If your employer does not have the capabilities to do that for you, set it up with your bank or discount broker to automatically withdraw the funds from your checking account each time you get paid.
If you haven’t started your EF yet, start now. Don’t wait until you see the big pass rusher coming straight at you. Get your O-line started now.