Saturday, August 20, 2011

The 4 Ways to a Better Emergency Fund

liferingImage by lism. via FlickrThe worst mistake people make in their journey to a better financial future is failing to create a fully funded emergency fund. Many people get into credit card trouble because when that inevitable emergency comes they have to go into debt to take care of the problem. They don't have the money to pay off their debts and the cycle repeats till they are over their heads in major debt. An emergency fund is your insurance to staying out of debt.


If you are a fan of Dave Ramsey you know his first "Baby Step" is to save up a $1,000 emergency fund before ever starting to pay off debt. That emergency fund is the number one way to be prepared for what trouble life hands you.


A rainy day fund or emergency fund is a cushion of money that keeps us afloat when times are tough but actually building one is sometimes harder than paying off debt. To get started building the fund you need a plan.


Create a Plan. The rule of thumb for an emergency fund is it must be at least three months worth of expense. So add up your mortgage or rent, utilities, food, health insurance, etc., multiply it by three, and that's your minimum goal for emergency savings. If you spend $3,000 a month, you will want to have at least $9,000 in your emergency fund. Having more than that depends on if you are self-employed or have any other issues that may affect you losing your job or any health issues. Another way to determine the size of the fund is your "sleep well" ratio. If you don't sleep well at night because your worried about a future layoff or other expense issue, maybe raise the amount of the fund till you can sleep well. It's a common indicator of satisfaction and peace.


Make it Automatic. It's hard to save money every month if you are doing manually. You may forget or be distracted by some work or family problem. It's best to make the process automatic. Set up a payrole deduction at work that adds money to you emergency fund automatically. If not at work set up an automatic transfer of money from your checking account to a savings account. It will all be simple and painless and won't be forgotten.


Where is the Right Place to Put it? It would be a good idea to put the money in a place where it could make some interest. But in today's savings environment a good place is hard to come by. The place has to be somewhere that it is completely safe and guaranteed not to lose principle. Today's low interest environment is bad for now but it may be better in the years to come. Accessibility is key for a good emergency fund.


Don't Touch it. The only real reason to access this money is for a true emergency. A true emergency is any event where you where you could not have predicted it's occurrence. It's not to fix that broken washing machine. You know that baby will someday breakdown, it doesn't qualify. An emergency fund is for a dire event not one that you are temporarily uncomfortable.

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