Grandma was right. It’s a smart idea to save some money for a rainy day.
The road to financial security isn’t a straight and easy one. Because life has a tendency to wreck our plans at the worst possible times, an important step to building wealth is creating an emergency fund to help you withstand the financial storms that you know might be headed your way.
(This is the third article in the “7 Steps to Financial Security” series.)
Think about it. If you were trying to do everything right with your money – investing for retirement, paying down your debt, and so on – but then faced an emergency of some kind, you’d be discouraged and tempted to reverse all those good steps you’d taken. You might want to dip into your retirement fund or start buying groceries on the credit card.
A reasonable cash cushion won’t assure for you a sense of security, but it will enable you to keep good financial habits in place when things get tough. And you know they will get tough at some point.
People get in debt when they think they are spending less than they make and then some “life curveball” hits them. No one knows what type of emergency they might possibly face – a car breaking down, loss of a job, health problems, home repairs or even the death of a family member – but it is wise to plan for the unexpected. You are not spending less than you earn if you don’t make provision to cover such unpredictable costs. Having an emergency account is just a good, common sense idea.
Figuring out how much to save is a personal decision, but it’s generally a good idea to have at least three months’ living expenses in a savings account. Some people who don’t like risk will want to save a lot more. But no one ever went through an emergency and said, “I wish I had saved less money!”
Keep It Accessible
Unlike your retirement savings, your emergency account needs to be something that can be accessed immediately. Bank savings accounts are great for this, but your financial advisor may have other smart options.
Make It Automatic
If you’re like most people and have a hard time socking money away for a rainy day, it helps to make saving money an automatic process.
Most employers offer the option to have a portion of your paycheck – either a percentage or a flat dollar amount – deducted from your pay and automatically deposited into your savings account. When that money is not in your checking account to tempt you, you are far less likely to spend it.
You also won’t have to remember to save. It just happens.
Live on a Budget
If you don’t have a personal budget, you’re playing Russian roulette with your financial future. Even people with high incomes and an advanced education can quickly end up in debt if they don’t have a plan for putting their money where it belongs.
By making a budget, which doesn’t have to be complicated or formal, you decide how your money is spent before it arrives. And keeping your debt under control is an important part – no, the most important part – of any household financial plan.
Other helpful resources for budgeting are available at daveramsey.com and mastermoney.org.