Today’s message is about Safety – but not things like “don’t run with scissors” or “wait a half hour after eating to go swimming”. What we’re referring to is the old concept of having an emergency fund. The primary thing that you should take away from this Safety discussion is Peace Of Mind.
An emergency fund is a vital component of your overall financial toolkit. You should have 3 to 6 months’ worth of expenses set aside in a liquid, stable account, such as a bank passbook savings account or a money market account. By “liquid” we mean that the funds are easily valued and withdrawn as necessary. By “stable”, we mean that the funds are not at risk due to market volatility, but also that there is some return in the form of interest to the account, however small.
Why do you need an emergency fund? First of all, even though it may seem like your employment is stable – there are millions of your fellow Americans who would tell you that nothing is stable. Your employment can dramatically change from one day to the next. With an emergency account, you can face this situation with much more confidence. That’s not to say that you wouldn’t be seriously impacted by a layoff, but having an emergency fund will help to cushion the blow.
Secondly, if you’ve got an emergency fund available, the next time your car breaks down, or you need a new roof, or the washing machine shoots craps, or you need new tires – you won’t have to go into debt to pay for it. And don’t feel guilty about using the funds in the emergency account, that’s what they’re for. Just be sure that 1) it’s actually an emergency; and 2) you repay the funds you’ve used (with the funds that you would have used to pay off those credit cards!).
Actually an emergency – we listed a few things earlier, such as your car breaking down or the washing machine falling apart, that constitute those day-to-day emergencies that in the past you might have reached for the old credit card to handle. With your emergency fund you don’t have to run up your credit card on these things. That doesn’t mean you raid the emergency fund to pay for those new golf clubs (sorry, not an emergency!) or to get that perfect pair of Jimmy Choos (also not an emergency). This fund’s use should be limited to real emergencies – things that you have to make tough choices about, like if I only had money for food or this “thing”, what would I choose?
Repaying your emergency fund – after the emergency is over, in order to pay back the money in your emergency fund to prepare for the next emergency you may need to divert some of your retirement savings temporarily. This has a higher priority than retirement saving, since the existence of your emergency fund allows you to maintain peace of mind as well as to keep from running up credit card balances in day-to-day life.