Friday, June 13, 2008

The Importance of an Emergency Fund

If you are living paycheck to paycheck you may also be living in constant fear that something is going to go wrong and you won't be able to pay your bills. Maybe your car tire will blow out as you are driving to work, or something will happen to an animal that needs to go to the vet, or perhaps you'll get sick. The worst thought is that you could potentially lose your job and lose that paycheck entirely. 
This is where having an emergency fund comes in. Everyone, no matter how secure your job, should have or be working towards having a minimum of three months worth of living expenses saved up. This should sit in an easily accessible interest bearing savings account, like an ING account. 
In the event that something happens and you need more than a couple of hundred dollars for it, this is your safety net. Yes, you could charge emergencies on your credit card, but then if you can't pay your balance with your next check, you will be charged interest on it. 

So why establish an emergency fund if you need to pay off debt? Shouldn't that money go towards something you are being charged interest on?
Well, it's a good point, but not really. Think of it this way.... if you lose your job or are unable to work, how will the minimum payments on those debts get paid? You would get slapped with late fees and it would damage your credit. It is better to have some way of at least keeping your head above water. 

In order to establish an emergency fund, figure out how much you need to cover your living expenses in a month. Be sure to include not only your bills, but expenses like food and transportation. You should aim to save between three and six months worth of expenses. 
Then, open a specific savings account. Again, I recommend ING as they have a good interest rate and the ability to open sub accounts that you can designate for certain purposes. 
Next put 5% of your paycheck immediately into this account. Don't round down. Even if it is an odd number, put in every penny of that 5%. I get paid weekly and I receive the same amount every week, so I have an automatic transfer going into my ING account. 
In the event that you get a raise, not only should you recalculate the amount that you are saving, but you should also raise it by 1%. You'll still be getting a financial benefit from your raise, and you will be able to hit your emergency fund goal even sooner.
Once you have reached your goal, either keep saving and put the extra into a high interest CD, or focus your attention back on paying off your debt.

Another piece of advice I was recently given was that once I reach my emergency fund goal I should continue saving but put half of it into my savings account and half of it into a Roth IRA. As my company has no retirement plan, it would probably be wise for me to start one. 

I've already had to pull from my emergency fund once as I had to have a cavity filled and it left me short on my rent for the month. I still have a way to go before I will have my 3 months of living expenses saved, but the progress I am making is very encouraging. 

If you would like a referral to open an ING Savings account, which has a $25 sign up bonus, please don't hesitate to email me at

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