Fred Harteis Editors Note: This is a great article because most of us don’t keep any emergency money around. This article gives some great tips on why and how to have an emergency stash.
A lot of people simply spend everything in their checking accounts every month and stop only when the money is gone. This leaves no cushion for the unforeseen, which can torpedo your ability to keep your head above water. To avoid this, create a fund to be used only in real emergencies.
From their comments, it's clear that members of the Armchair Millionaire community are big believers in emergency funds. When we recently asked about their emergency savings, here is some of what we heard:
"We currently have about four months' worth of emergency savings and are working on building it up to six months. We have dipped into our savings from time to time, usually for home repair. Once for a vacation ... not a good idea, but we had a lot of fun." -- KS
"I always keep three months of my income in my money market account, although these days, it seems like a health problem or an extended layoff could easily last more than three months."-- Harry
"I have four months of living expenses, with a goal to compile one year's worth. I use funds from this account as a last resort but do access them from time to time, most recently to pay in advance the next phase of braces for my child. Hate to go in there, but also smile when I don't have to finance this type of expense." -- kirkisms
The Armchair Millionaire's Q and A on Emergency Funds
What's it for? Your reserve fund is for the curve balls that life is bound to throw at you: a leaking roof, a blown transmission, a hot water heater gone cold. It's also for unexpected life changes, like the loss of a job, a divorce, or a major illness. (Sorry, that closeout sale on designer clothes does not constitute an emergency.)
How much should you have? The equivalent of three to six months' worth of living expenses is a good guideline, but take your own situation into account when deciding. If you're part of a two-income household, you might be able to get by on the other income if you lose your job, for example. If you're self-employed and have an irregular income, you might need more to see you through the lean times.
And while you want to be prepared, don't go overboard, either. There's no reason to tie up more than you'd ever reasonably need in an emergency fund when that money could be working for you in a long-term investment.
How should I save it? If you don't have a chunk to plunk right into an emergency fund -- and most of us don't -- you'll need to build it over time. Arrange to have a set amount -- say, $100 -- automatically transferred from your checking account into your emergency fund each month. You'll slowly (and painlessly) build up your reserve.
Where should you keep it? Since you'll be tapping these funds in an emergency, it's essential to be able to get the money quickly and conveniently. A savings account, a money market account or a money market mutual fund will all keep your money highly liquid, while paying you a bit of interest. Shop around for the account that will give you the best rate with no monthly fees.
Why not just charge it? Many people choose to forego an emergency fund, figuring that they can always reach for their credit card instead. If you're thinking about this route, be sure to consider the real costs.
If you pay that $3,000 car repair bill from your emergency fund, it'll cost you exactly $3,000. But if you charge it on your 18 percent interest credit card, and take a year to pay if off, it'll cost closer to $3,300.
You'll also run into the possibility of hitting your credit limit. If you do decide to rely on credit for emergencies, consider a home equity line of credit. Interest rates are much lower than for most credit cards, and the interest is usually tax deductible.
THE BOTTOM LINE: When the chips are down, you need to be able to protect what you have. A safety net of cold, hard cash will go a long way towards doing that.
Source: cnn.com
About Fred: Fred Harteis is the president of The I Team Organization. Fred Harteis provides Team Business Series as a service to small business owners.