How To Get Your Finances Under Control – Step 5 Establish an Emergency Fund
Proverbs 27:12 – A prudent person foresees the danger ahead and takes precautions.
The simpleton goes blindly on and suffers the consequences.
This is part of the series How to Get Your Finances Under Control
Now that we have a budget in place, we need to start an emergency fund. Following a budget and having an emergency fund in place are the two most critical steps in getting your finances under control.
An emergency fund is the fund you will use to handle emergency or unplanned expenses. In step 4, we established a zero based budget, in that our income minus expenses equaled zero. Or in other words, every incoming dollar had an expense line item in the budget. Also remember, we did our budget on paper prior to the actual budget month. So how do you handle unplanned expenses such as the car breaking down, the dish washer breaking or the hot water heater unexpectedly going out? How do you handle your 10 year old coming home from school and asking for $20 to go on that field trip tomorrow that you didn’t budget for? The answer is the emergency fund.
If you’re like I used to be, whenever something like this happened, we used our credit card. An emergency fund allows you to fund these unexpected items without using a credit card.
Start out with an initial emergency fund of around $1000. There is no correct number here, as the amount needed will be driven by things such as how old your cars are, how many children you have, etc. I keep about $1500 as that is a number that makes me feel comfortable. Remember, we have 6 kids so our emergencies are sometimes a little more expensive. I wouldn’t go below $500, and more than $2000 is too much.
At this point many of you are asking, too much? I’ll explain later in this series, but part of getting your finances under control is going to be getting rid of your credit cards. For now though, just hang in there…I promise I’ll explain.
If you have you emergency fund already, great, if not start aggressively saving one today. We want to establish this emergency fund as quickly as possible.
Dave Ramsey in his Total Money Makeover Book recommends $1000 dollars initially as part of Baby Step #1 and then once you’re debt free, bump it to 3-6 months worth of expenses.
Your emergency fund should initially be kept in a separate account and not with your spending money. This reduces the temptation of spending it. I actually keep mine in two separate accounts. Half in a CapitalOne High Yield Money Market account and the other half in an INGDirect savings account. With the CapitalOne account, I have check writing privileges. This is very convenient when you have an emergency that you have to pay for now. Transferring your money from your INGDirect takes about 3 days. For an emergency fund, that is a too long for me. Both of these are high interest bearing accounts and both banks have great online banking and customer service. If you are interested in an INGDirect savings account, contact me, and I will send you a referral. You’ll get $25 and I’ll get $10 when you sign up.
It doesn’t matter where you store your emergency fund. Remember it’s not an investment, so you want it to be liquid and relatively easy to get to, but not too easy.
Defining what constitutes an emergency. I would recommend writing it down. For us it is simply any unplanned expense that can’t wait until the next budget month to address. If you don’t define what an emergency is and agree on it with your spouse, things like big screen TVs, iPhones, that cool new widget, etc will become emergencies.
A couple of months ago, I took my car (a 2001 Nissan Sentra) in for an oil change. Turns out, two of the tires where wore through to the steel and my front brake pads where worn to the metal. So a free oil change turned into a $600 expense. Was I happy, of course not, but I wasn’t worried. We used our emergency fund to pay for it. There was something really awesome about driving away from the dealership with new brakes and tires that I payed cash for. I didn’t go further into debt, it was a great feeling.
Life throws you curve balls everyday, sometimes they are little inconvenient ones and sometimes they are really expense and inconvenient ones. The emergency fund allows you to deal with these unexpected expenses without going further into debt and without blowing your budget.
For those of you who already have emergency funds, where do you have yours? How much of an emergency fund do you have and why that amount?