Advantages of having Money Saved for Emergencies

Challenges confront people on a daily basis that reach into their paychecks or in the worst case scenario, have them building debt on a credit card or through personal loans.  Very few of us remain unscathed from the untimely break down of a fundamental piece of home or automobile equipment, accidents, untimely deaths or other obstacles in life.  It seems to never fail that the garbage disposal breaks down over Thanksgiving when you’ve just spent most of your extra income on a big family dinner, or the transmission goes out in your car the same month that you had to have the air conditioning unit worked on in your house.  An old friend you’ve known since childhood who resided on the other side of the country suddenly dies and you need to buy an airplane ticket, rent a car and pay for a hotel room in another city.  The only thing predictable about life is that it is unpredictable and these routine emergencies cost money to repair and deal with.  Having a nest egg for emergencies can help you go through life with a greater sense of resilience aided with the comfortable knowledge that you are prepared to deal with life’s ups and downs.

Many people avoid starting a savings plan because they believe they do not have enough money to have anything else deducted from their income.  The reality is that we all have extra dollars in our budget that we can multiply with a simple plan. 

Financial Freedom Basics

There are four basic steps to reaching financial security and freedom.  Financial Security is not a pipe dream but a very real and attainable goal for anyone, including the person who is living on a low fixed income. 

Step 1:

Set Goals.  For every achievement there first came a plan.  Each person’s financial goals are personal and will differ.  What is one of the most important things that you would like to attain financially?  It could be having enough money socked away that you can send a child to college, open your own business, pay for a wedding, buy a new car, buy a home, take a special vacation, retire early, but most importantly – be able to pay for emergencies.  Sit down and think about what your goals are and start with one that is most important to you and write it down.  The first step to reaching any goal is to have a plan.

Step 2:

Take advantage of Compound Interest.  It can be tempting to pull out some cash from each paycheck and hide the money in a jar in your garage, but you are loosing the advantage of FREE money that will compound over time.  “The most powerful force in the universe is compound interest,” as stated by one of the most brilliant men of our time, Albert Einstein.  The principal of compound interest is simple.  You give your money to a bank, or the treasury department or some other financial institution and they pay you a percent based on different factors for you to allow them to hold your money.  Here is a simple example.  You put $100 in the bank and it earns $2 in interest over the course of the year.  The next year it is $102 that is earning interest.  That does not sound like a big number, but it is free money that grows and that you are constantly adding to on the bottom line. 

Step 3:

Take Advantage of Any Automatic Withdrawals from you Paycheck or your Checking Account.  When you make something automatic, it takes the decision making aspect out of each paycheck away from you and it also sets in place a system that will allow you to build wealth.

Step 4:

Emergencies and the Nest Egg.  Try to build up a savings level that is equal to 3 months of your living expenses and build you’re other goals on top of that.  Try to build up your level of savings to something that equals 10% of your net pay.

The Details

It is highly recommended that you set up an automatic savings plan as part of your pay check.  Many companies offer options for payroll deductions that allow you to save money before your pay roll ever hits your checking or savings account.  Check into participating in your company’s 401K retirement savings plan.  Most companies, even during difficult financial times, will offer some sort of matching contribution to the retirement plan in your name.  For instance, you may elect to have 4% of your pay check deducted as a 401K retirement contribution and your company may match that with a 4% contribution of their own.  This can be one of the single greatest wealth building machines for a young person.  Starting a savings plan and retirement plan when you are young means that you are taking advantage of compounding interest and will set yourself up for the option of an early retirement.

Outside of your 401K or retirement savings plans, which are set up to be long term savings and not to be accessed for emergencies, you will need to have something for short term and mid term savings.  If your company will allow it, set up a payroll deduction account with Treasury Direct to purchase U.S. Savings Bonds, in particular the I Series, or Inflation Indexed Bonds.  The beauty of this account is that you can set the amount of the payroll deduction to make it as painless as possible – such as $10 per pay check and the money gets transferred out of your pay check and into your account with the U.S. Treasury.  Once that account reaches $50, a U.S. Savings Bond will be automatically purchased for your account.  The U.S. Treasury Department has stopped printing paper savings bonds (if you still have paper savings bonds don’t panic – they are still financial instruments).  What this means is that when you purchase a bond it is recorded in your account at the current interest rate of the month the purchase was made.  Interest accrues the same exact way as it did with paper savings bonds, earning interest every month.  When you go to sell the bonds – you have to wait one year from the date of issue but can hold them up to 30 years and they will continue to earn and compound interest – the total amount of your purchase plus interest can then be transferred into a bank account of your choosing electronically.  The beauty of the I Series Savings Bonds is they guarantee you an interest rate that is equal to or higher than inflation. 

There are other ways that you can earn greater amounts of interest or return on your investment but those investments require greater money put down on the front end. Example:  At a local bank they advertise a CD (Certificate of Deposit) for 59 months with a contribution of $1,000 at an APY (Annual Percentage Yield) of 2.25% which will guarantee you a return of $585 after 59 months.  Typically, the more that you put down and the longer term you agree to let the bank hold the investment, the greater yield you will receive.  There are penalties for early withdrawal so this money has to be set aside above and beyond your basic emergency fund.

If your company does not offer any sort of payroll deductions, most banks will allow you to set up your checking account so that you can automatically have a set amount of money pulled out at set dates during the month to be put into your savings account.  Once your nest egg has grown you can open a money market account, which requires a bigger minimum balance to open it and does not allow you to make more than 2-3 withdrawals per month, but will pay a higher interest rate.  A Money Market Fund is a perfect place for you to keep your emergency nest egg once you have grown it to the minimum amount needed to open the account.

Don’t Say You Don’t Have Enough Money to Save

Many people make the mistake of claiming they don’t have enough money to save each pay period.  Most people get paid, then they pay some bills, buy some things, go out to eat or entertain themselves, and then if there is anything left over they throw it in their savings account.  This is not a plan for financial security.  You need to make a decision that having money set aside for an emergency or bigger goal is important enough to you that you are willing to set aside money on the front end, as soon as you get paid.  If you are nervous, start small.  Small savings will grow into big savings over time and with compounding interest.  Try to make it automatic and something you don’t have to wrestle over every time you get paid.  If your budget is truly cinched tight, look at your lifestyle and see where you can cut back on some expenses to allow a few extra dollars so that you can have an emergency fund.   Many people buy a cup of coffee or a bottle of water every single day.  That is a minimum of $1.50 a day and over two weeks that equals $21.  That is your savings right there.  That $21 savings set aside every 2 weeks when you get paid 26 times a year becomes $546 after one year, not including interest.  Take a hard look at your life and you will find other ways that you can slice out some expenses here and there. 

No one wants to be at the mercy of life’s challenges when they hit and be unable to fix a furnace that broke down during the coldest month of the year, or an automobile repair a week before you are set to leave to visit family.  If you have enough credit available on a credit card you can pay for the emergency using that at 14 – 21% interest and who is getting rich on that deal?  The credit card companies are getting rich.  If you build up your own nest egg for emergencies, you can be secure in the knowledge that you can take care of your own issues without having to lean on family or friends.  You can move through life with the comfort and security of knowing that you are building a strong financial future which will allow you to not only deal with emergencies, but over time, build financial freedom.