Imagine driving in a snowstorm on your way to work when suddenly your car hits a patch of black ice and veers off the road and into the ditch. If you’re typical of the average consumer, you reluctantly whip out the credit car and pay for the towing service. You hadn’t planned for any added expenses, so the cost of the tow adds to your existing expenses, something you can ill afford. But the guy with an emergency fund has less to worry about. While he may use that credit card to pay for the tow, he is assured that he has the money to pay off the bill when it arrives.
Unexpected events can happen any time. A car breakdown, the loss of a job or a sudden illness can send you into a financial tailspin. But a carefully crafted emergency fund can give you peace of mind since you’ve planned ahead by salting away a portion of your income into that special fund.
An emergency fund is not a long term investment. The money needs to be available at a moment’s notice. However, that emergency money is often a temptation to use as it’s easily accessible. Some people explain away the need to use what they’ve saved, though there is no real emergency. They promise themselves to replace what they took out. Of course, that seldom works. That’s the greatest drawback of an emergency fund. It requires discipline to use the money only for real emergencies.
An emergency fund should be an important part of every family budget. In today’s uncertain economic climate there will be more chances that something will derail your plans and create financial hardship. You simply can’t wait until the loss of income has you scrambling to pay bills.
How much should you salt away into that special fund? That depends on your income source and the amount of expenses you carry. Some say that putting away 10% of your monthly income to your fund should be sufficient. In the case of a job loss, you may need as much as 3 months of your monthly salary to tide you over while you find a new job.
How much you save depends on the state of your health, your age and your responsibilities. If you’re young and single, you may build up your fund slowly. The married man needs to salt away more. He can choose to set aside a part of his salary. But if debts are high, it may be necessary to trim some expenses so the extra money can be put into the emergency fund.
If you’re not saving as much as you should, you can use any raise in pay, your tax rebates or monetary gifts to expand your fund. It’s a good policy to involve every member of your family in contributing to the fund. After all, emergencies affect the whole family.
Obviously, a savings account that offers a reasonable interest rate is the first choice for an emergency fund. You want to put the money where it can grow until you need it. The best way is to open a dual account that requires two signatures, so you’re not tempted to withdraw it without the approval of your spouse.
While the purpose of the fund is to provide the money necessary to service sudden problems without occurring additional debt, it can be used in a pinch to reduce some of those high interest rates on credit cards. For example, if you are negotiating a debt consolidation loan from the bank, but can’t make card payments while you are negotiating the loan arrangement, you can use some of that emergency money to pay off debt until the loan is in place.
If your debts are not too high, emergency money can pay off debt as they come due and helps avoid the trap of revolving credit payments.
An emergency fund offers you the peace of mind that you are prepared to handle any situation that may arise. If you’ve built up more than enough money, you may want to consider giving a portion of it away to charity and help the less fortunate who need support and financial assistance. That is yet another important reason to have an emergency fund.