I always try to approach my financial counseling from a behavior standpoint, often using materials I wrote a while back called, “It’s Not About Money”. Why did I give it that title? Simply put, personal finance has very little to do with money or math – it is about what you do with the gray stuff between your ears (your brain, for those of you who didn’t have to do the gross dissections in high school biology). With that in mind, people always want to know how it is possible to survive without debt, even if there is an “emergency”. The answer is one you’ve heard me proclaim before – an emergency fund.
The first thing people often have trouble with is defining what constitutes an emergency. As you may have noticed, I titled this post “Country Music Song Survival” because I believe it puts a good visual of what qualifies as an emergency. If, in the span of a week, your wife leaves, your dog dies, your truck breaks down and you lose your job, you probably have an emergency on your hands. Unless you can go to Nashville and pitch a hit song based on your life experience, you’re stuck unless you’ve got money saved for emergencies.
If however, in the span of a week, you go on vacation, buy that ski boat you’ve always wanted, put 24” rims on your family’s van and then get your mortgage bill in the mail and wonder how you’re possibly going to make that payment, you probably just didn’t think things through. So what is an emergency, as far as it relates to your finances? An emergency is a VERY LARGE unexpected expense OR a combination of several unexpected expenses that occur within a short period of time that overwhelm your budget. The only answer that I recommend for these scenarios is an emergency fund.
The second thing people often struggle with is what they should use as their emergency fund. My only recommendation is that you keep it simple to access and as safe as possible. Your goal is to have the money there if you need it – not to make a bunch of interest income. We’re talking a savings account or a money market account here. A credit card is NOT an emergency fund. Stuff you can sell is NOT an emergency fund. Your retirement account is NOT an emergency fund. Your parents/children are NOT an emergency fund. Your car title is NOT an emergency fund. CASH that you can get to in a serious pinch is an emergency fund.
The third thing people often struggle with is how much they should save as their emergency fund and how they should save it. I get LOTS of questions about this one. To save, you must make saving a priority. Maybe you have things you can do to earn extra income or maybe you can have a yard sale. Maybe you just need to tighten up your budget a little (you are making a budget each month, right?!). Whatever it takes to be able to save some money aside (and that won’t get you arrested or killed), DO IT.
How much to save is a very tough question because every family’s needs and incomes are different. Virtually every financial counselor has his/her own input on this. For example, Dave Ramsey suggests you start with $1,000 as a “baby emergency fund” even before you try to get out of debt, then eventually work up to 3-6 months of household expenses as your emergency fund as you get your debt reigned in. Let me ask you this – is $1,000 in the bank enough for you to feel protected against having to use a credit card if an emergency arises? For some, that’s plenty – for others that isn’t even close.
My advice is this: start with the goal of saving the amount of exactly one paycheck. Doing this can help you escape the living paycheck to paycheck mentality. Once you’ve accomplished this goal, focus more on getting out of debt, but continue to save until you have a month of paychecks saved. If you only get paid once per month, this goal has already been met! For the rest of you, keep at it! Now let me ask you this, is a month of paychecks in the bank enough to for you to feel protected against having to use a credit card if an emergency arises? In my experience, way more people will say “yes” to that question than those who would think $1,000 is enough. Once you get out of all debt except your house, then I agree totally with Dave Ramsey and say you should save 3-6 months of expenses as your emergency fund.
Does that help? Does that give you some direction on the purpose of your emergency fund, where you should keep that fund and how much to save? I hope so. Just as important, do you have a question you want to ask? Ask it here!
Wow Daniel….that was really original. :-p