A survey revealed that 4 in 10 Americans did not have $2,000 available in case of an emergency. This means that if their car broke down, the air conditioner went on the blink, there was an emergency room visit, or a paycheck was delayed by a week they would need to go borrow money on a credit card or from another questionable source such as a payday loan store. This type of borrowing has a way of feeding on itself. You put a $2,000 transmission on a credit card with plans of paying it down quickly, but then you’re paying interest on the credit card in addition to your regular bills. Next thing you know, something else happens, and then you take a vacation, then there is a wedding in the family. Before long, you’re looking at $50,000 in credit card debt and no way to pay it off.
Many of the new health insurance plans under the Affordable Care Act also have huge deductibles and out-of-pocket maximums. An appendicitis or car accident could easily result in out-of-pocket costs of $10,000 or more since many plans have deductibles of $7,000 or more. Nevermind that the health insurance bill was sold under the idea that no one should go bankrupt because of a medical emergency. Given that 4 in 10 don’t even have $2,000, an accident or illness could still bankrupt many people even with insurance.
This blog is all about investing and I think investing is critical to becoming financially independent. Establishing an emergency fund is far more important than starting to invest, however, and should come even before putting away money for retirement. Without it you’ll end up selling stock or cashing out a 401k plan to pay a bill. You’ll end up sending lots of money away to pay for interest on credit cards and consumer loans that could have gone towards paying cash for cars and investing for your future. With an emergency fund, a broken down car is an inconvenience. Without one, it is a crisis.
To start an emergency fund you obviously need to live on less than you make for a period of a few months. The best thing to do is to start putting away $300-$500 per month when you first start your first job. As you get a raise, start putting a little more away. A good emergency fund will contain 3-6 month’s worth of expenses, or somewhere between $6,000 and $12,000.
Note the emergency fund should be for just that – emergencies. There are no emergency vacations or emergency things you need to acquire. It is for things like a lost job, a car repair, or a critical home repair.
After you have an emergency fund together, don’t stop there. Keep siphoning off some of your income and investing in individual stocks or mutual funds. Also, start putting money into a retirement account such as a 401k and into kid’s college accounts. As your investment account grows you can reduce your emergency fund a little, but keep at least 3 month’s worth of expenses in it. If you need to spend any of it for any reason, be sure to replenish it as quickly as possible. Not doing so is inviting trouble.
Emergency funds should also be grown in times of trouble. If you know that lay-offs are likely or certain, start putting more money away and building your safety net. If you have money int he bank you’ll be able to search and find a good next job rather than taking whatever you can get. You’ll also be in a better position to negotiate salary and benefits. A strong negotiator needs to be able to walk away. An emergency fund will give you that option.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.