Learning to Love the Emergency Fund
Monday, 14th April 2008 (by J.D.)This article is about Basics, Planning
I wasn’t raised in a culture of saving. My parents never made it a habit, and so could not pass the skill on to me or my brothers. In fact, I didn’t establish my first savings account until three years ago, when I was 36 years old! (I had a passbook savings account as a young boy, but it never had more than $5 in it.)
Minor-league start
Soon after I decided to take control of my finances, I opened a savings account at my credit union. I used it to build a “starter” emergency fund. I began to save for unexpected disasters. It took nearly a year, but eventually I saved $1,000. That wouldn’t last long during a major catastrophe, but it was enough to cope with car problems and leaky roofs. I threw the rest of my money at debt.
I also opened another account, which I used for targeted savings. For example, when I decided I wanted a Nintendo Wii, I put my garage sale money into this second account. I sold some books to raise the balance so that I could afford my new toy
This system has worked well for me. I still have $1,000 in my primary credit union savings account, and I’m using the secondary account to save for a new vehicle. But the credit union only pays me 0.37%. That’s not a lot. When I finally paid off my non-mortgage last fall, I started a real emergency fund using a high-yield savings account.
Major-league savings
After eliminating my debt, I suddenly had a sizable positive cash flow. I could have used this money to buy all the comic books I ever wanted, but instead I saved it. Based on feedback from GRS readers, I opened an account at ING Direct.
Every month I add a few hundred dollars to my emergency fund. I’ve also been stashing away small windfalls, such as my Christmas bonus, or checks for my birthday. As exciting as it was to repay my debt, it’s even more thrilling for me to build wealth. One of my goals for 2008 is to save $10,000. I’m half way there; I’ve accumulated a little over $5,000.
Now that I’ve developed the habit of saving, I wish I had done so earlier. When something bad happens — when I’m rear-ended while in a rental car, for example — I no longer panic about how I’ll find the money to deal with it. Sure I’m concerned, but I know that I have a cash cushion that will protect me if something really terrible happens.
Getting in the game
If you’ve delayed starting a savings account, consider opening one today. It’s easy. Many high-yield online savings accounts have low minimum balances (just $1, in many cases), and some allow you to create automated savings programs with which you can schedule regular transfers from your existing checking account. When you get started, keep the following in mind:
- Choose a bank that fits your style. My wife keeps her money at the bank she’s been using for the past 20 years. She earns almost no interest, but it’s convenient for her. And because she has self-control, she’s not tempted to use her savings for other purposes. My emergency fund is with an online bank because I want to earn higher interest, and because I like that my money takes some effort to get to — it’s an additional barrier between me and impulse spending.
- Prioritize. Having an emergency fund is important, but it’s not the only thing. Most people should start small, setting aside $500 or $1,000. Next, they should focus on paying down high-interest debt. Finally, they should fully fund their retirement accounts. When these goals have been met, then it’s time to beef up emergency savings. Your priorities may be different. If you worry about potential problems, then by all means boost your emergency savings first. Do what works for you.
- Don’t be discouraged by saving small amounts. If all you an afford is $25 each month, then save $25 each month. When I started, I was only setting aside $50 per paycheck (or $100/month). It took a year to save that first $1,000. You can jump-start your emergency fund by using a windfall. Did you get a tax refund? Expecting a $1,200 rebate check? Consider using that to start a savings account.
I used to live paycheck-to-paycheck: no matter how much money I earned, I could find ways to spend it. My outlook has changed. And though I sometimes wish I’d discovered the joy of saving when I was younger, I’m glad to be learning it now. I love watching my balance grow every month.
If you’re just starting an emergency fund, you may also be interested to read:
This article is part of Financial Literacy Month. It is also part of the MBN group writing project for April.
J.D.,
An emergency fund is actually a risk management vehicle. Your car accident example brings to light the concept of “risk sharing,” which is also an element of risk management.
Where I am leading here is, now that you have a large emergency savings account, you have a greater capacity to bear more risk with insurance (and other areas).
To keep my comment brief, you should consider increasing all of your insurance deductibles to the maximum level. In other words, you have the cash capacity to “self-insure.”
Please think about that if you have not already done so…
Cheers…
“Choose a bank that fits your style” - I don’t think I’ve ever thought of it like that before, but you’re right. For me, it’s tough to not touch money I know is right around the corner…online banking helps me keep my greedy little hands off my money.
Great tip that may seem intuitive to some, but I’d bet for the vast majority of folks, they’ve never thought of it like that.
-Wayne
And the best line on your account statement is “Interest Paid Year to Date $190.65″. That’s pretty good going considering it’s only April.
Plonkee, I agree that the interest line is great, but some of that number is from referrals to other customers. ING counts their referral bonus as interest.
Financial Philosopher — you’re right, I need to increase my deductibles. Or at least price the difference.
Who is this Wayne character? Joking he does great stuff and tickerhound.com
Over the past five months, my EF has grown to just $1,000. I’ve just discovered that my labor union will most likely call for a strike in the next 60 days—a year ago, I wouldn’t have had the financial backup to endure a few days (hopefully just a few days) of not being paid.
The peace of mind that my EF gives me is immeasurable. That peace of mind acts as positive reinforcement to ensure that I’ll continue to add money to my EF (when my debt is paid off), and to continue to economize so I can become even more financially secure.
We, too, our learning to love our emergency fund.. We just have a little over 5K and are also working up to 10K.
We recently used our e-fund when we had some major car repairs, and I felt good about knowing it was there and using it, but even better when we paid it back after just a few months!
I believe the emergency fund is just as important as the retirement fund, if not more important. If you don’t have sufficient money in your emergency fund, then you’ll be more likely to tap your retirement fund and take the penalties involved with that. So, for me, I prioritize the emergency fund over the retirement.
Plus you can decide at the end of the year that you want to shift money from the emergency fund to a Roth IRA. Bingo, tax benefit at end of year, financial cushion for beginning of year.
@J.D. - Another great post. I too am working on my emergency fund and it is steadily gaining. I knew many of these principals before I started reading your blog but I hadn’t been able to actually put them to use. Your everyday real life IMOaccounts have enabled me to do so. I am headed down the path of financial freedom for sure.
@Financial Philosopher - I had not thought of “self-insuring” in those terms before. That is a great idea IF you can assume the risk with your own savings.
Long time listener, first time caller.
(I’ve always wanted to say that!)
I just want to say that you have no idea how much this article has helped me! I won’t bore you with the details of our financial struggle, but suffice it to say that we are a one-income family living paycheck to paycheck. We have recently tried and failed to set up our emergency fund…actually we got it, then had 2 major home repairs that wiped it out. I have been VERY discouraged, but reading this post today has given me the encouragement I need to get my mind where it needs to be. Thanks a bunch!
I’ve read so many great reviews of ING it makes me wonder I don’t have an account there! I particularly like the sub-account idea where you can basically create targeted savings account as you mentioned above. We call those sinking funds around my house, because we sink money into them each month to pay for annual or semi-annual expenses (car tags, Christmas, insurance premiums, etc.). Having sub-accounts would make the accounting much less messy. I think I’ll finally take the ING plunge.
I had been putting my “emergency fund” money into stocks and bonds. I knew this went against conventional wisdom, but figured I was OK because I also have a HELOC available to me.
Over the past few months, I had a set of occasions that warranted withdrawing emergency funds. And I did that — my taxable stock accounts are down to 0, and I took some money out of the HELOC. Not a problem, I will have the HELOC paid back off within a couple months and then start rebuilding my emergency fund. But now I’m inclined to follow the more conservative route of having that money in a high-interest FDIC-insured savings account.
While in the end everything turned out OK, my stock withdrawals were at a loss — just because the stock market has been terrible lately. And even though I could have avoided the stock withdrawals and used the HELOC for everything (at a reasonable interest rate) I just didn’t feel comfortable with that. I wanted rid of the HELOC debt ASAP.
So my lesson is learned, I will follow the more conservative approach. My plan now is to put all (non-401k/roth) savings into a high-yield savings account — because I may want to tap that money over the next five to ten years.
I don’t know if you do or not, but having a checking account through ING direct is really good for an emergency fund as well. We use the ING checking for our Christmas fund and our car-related expenses. So, we get a debit card with that and use it whenever we need to make car-related purchases. The real benefit comes in when we need to access the emergency fund. We can transfer money to the Checking from Emergency, and it is available immediately.
Obviously, this won’t help the impulse buy disease, but if you can control that, you will have money almost immediately when you do have an emergency.
This system has worked well for my family, I hope that it will work well for you.
As for the self-insurance: we used a High Deductible Health Insurance plan a couple years ago, but burned through that money with our first daughter. Now, I would like to get back to that because we spend so much on our group health insurance now it is ridiculous. $5000 a year! I think that I might be able to find my own coverage for less than that. Having a large savings account sure makes it easier to be prepared for those emergencies.
It’s definitely something you have to get used to. Like you said, it is a great feeling to know that unless there are a string of several emergencies in a row, you’ve got everything covered. It’s one less thing to worry about, and gives you a bit of breathing room.
Thank you so much for your encouraging blog! You don’t know how much it means to someone who is discovering money management for the first time in her life (age 41). It means the world to have a support system like this.
Great article–thanks!
How much should ideally go into an emergency fund? I’ve already paid down my debt and–thanks to an earlier article here–opened a savings account with ING, a bank I definitely recommend to others now.
I’ve read lots of advice that says the emergency fund should be half your annual salary, and you should have that much in a savings account before you even start investing in other places.
Much of it depends on assessing your specific needs of course, but are there any other general rules about the emergency fund? Any more advice would be great.
Emergency Fund Accounts are essential. There is almost always something that comes up and having the money available in an interest bearing account to cover unexpected expenses is far better than having to use a credit card.
@Zack
My e-mail is down, so I can’t reply to you directly. There’s a lot of different advice out there about how much to put into an emergency fund. A lot of it depends on your own disposition. We’ve actually discussed this a couple times before:
* How to start an emergency fund
* Ask the readers: How much in an emergency fund?
Those two articles may give you some useful info.
Many good posts, however I think an emergency fund should be readily accessible and liquid, but not too available. A money market account with check writing privileges meets these requirements. Real estate,CD’s,stocks, bonds and collectibles do not qualify. You are not looking for the highest rate of interest (also the highest risk) you are looking for a place were the money is available when needed. Most financial advisors recommend 3 to 6 months living expenses.
I disagree about priorities. THis is what I would suggest.
People should make the minimum payments on their debt. (Keep reading.)
Cut back on expenses till you have balanced your budget.
Determine how much more you can devote to debt repayment.
Put 1/2 of that toward debt repayment.
Put the other 1/2 in an emergency fund.
When your emergency fund is equal to 1 month of expenses, you can cut monthly savings back. (You still want to eventually have 6 months of savings.)
At that point, start saving for retirement.
Otherwise, a small set back can lead to more debt and perhaps people clearing out their retirement savings while maxing out their cards.
I’ve recently been appreciating my emergency fund lately. We’ve had a medical issue going on in the family that involved hospitalization for a few days and surgery, and it’s great not to have to worry about how to pay the insurance deductibles and copays.
The other great thing about an emergency fund is that our finances have enough breathing room that I’ve just stopped paying attention to prices for a little while. Whatever the hospital cafeteria charges for that food item I want, I pay it. The sick person wants a new book to read or clothes that are comfortable for a hospital bed? Done. It might not fit into many people’s idea of “emergency spending”, but it’s making it easier to get through a tough couple of weeks. Having financial discipline most of the time means you have the cash to spend when you need it.
This is a bit of a tangent from the thrust of the article, but after reading it, I wondered why some people are so resistant to having an emergency fund. It doesn’t seem to matter how much we tout the advantages of having peace of mind even when unexpected expenses or lack of income occur.
I found myself asking whether there are certain group of people who are so accustomed to chaos and fear where their finances are concerned that they don’t really see the need to have them be “safe”. In fact, they seem to be proud of their leaps from crisis to crisis.
(Me, I grew up with middle-class frugality and financial conservatism — I had to learn that it was OK to take calculated risks and make mistakes (aka “learning experiences”.)
OK. End of tangent.
J.D. does it again!!! Another great post. I already have a retirement account with ING through my work, but not a savings account. I like the idea of sub-accounts. What is the best thing to look for when setting up for an emergency fund?
@Frugal Dad - good point about the sinking funds. IMO, an emergency fund is for just that–an unforseeable emergency. Getting hit by an uninsured driver is an emergency; replacing the clutch after 80,000 miles is not. The clutch should be paid for out of a sinking fund while leaving true emergency funds intact.
J.D. I’m in almost the same boat as you, just starting 3 years sooner. I’m just glad that I was able to see the light. Right now I’m on track to have a $2000 emergency fund before the end of the year and I’ve never had that before.
No to just get rid of the rest of that pesky debt….
I love my ING account. Super easy to use and I have several different accounts (emergency, vacation, etc).
I started my emergency fund with ING 4 years ago for the free referral bonus. The referral interest did confuse me at first but you get used to it quickly.
Now the account has grown and I have a goal for 6 months of real world expenses by summer. On track too!
You mention in your post starting a small emergency account first - paying down high interest debt second (which is where I am at currently) - then fully financing your retirement. What exactly do you mean by that? Would that be your strategy if you were 20-something?
Thanks for the advice!
A great post! I agree about jump-starting your emergency fund with a big chunk like your tax refund. That’s what I did. Having that cushion in place really motivated me to get serious about paying off my credit cards.
We’re a huge fan of the emergency fund. We’ve had to use it a couple times, and it has been a blessing.
I discovered your site last November and took to heart the idea of an emergency fund and created one with the help of some snowflaking (which had an additional benefit of cleaning out the closet, which in turn made the wife happier as well, talk about a win/win situation). A string of plumbing mishaps has severely dented the emergency fund and left me feeling rather bummed about it’s depletion in such a short time. I am glad that it was available, I just wish I could have let it grow a bit more. This post has re-ignited the fire to rebuild our emergency fund to a higher level. Thanks for the booster shot. Time to go shake some more snowflakes out of the storage spaces.
I started my emergency fund my last year in college, in anticipation of potentially not finding employment upon graduation. I had about $1800 saved up when I graduated, and had to tap into it for about $500 since then. I am now building it up with $500 every month until it reaches $10k, like you. My problem is I feel like I *can’t* touch that money, for anything. I felt awful taking out that $500 when I needed it (though I was glad it was there). I get so into the mindset of “this is not for touching” that when I need to, it’s hard.
JD, what do you plan on doing with the interest that accumulates in your emergency fund after you save your $10k? Will you count that towards bonus emergency fund money, or will you allocate it elsewhere?
Ah, the halcyon days of having enough money to save…
ING is great for money that you won’t have to touch right away (say, saving for a Wii or some other “want but don’t need”), but I don’t like it for emergency saving because it takes about 2-3 business days from the time you set-up the transfer to the time that you see the money in your linked account.
If you had a Credit card, you’d because you could use that to make whatever payment, then set up your transfer and pay off the card right away, but if for whatever reason you just needed CASH right then and there, you’d be in trouble.
So I guess the best case scenario (other than not needing to have the money for an emergency) would be:
1. A easy to access $500-1000 “emergency emergency” fund
2. A interest bearing “back-up” emergency fund.
We have an emergency fund in the form of a credit card as well. It is backed up with an emergency fund in a high-yield savings account and a money market checking account. If we find ourselves in need of the money immediately (since I rarely carry the emergency fund debit cards around with me), we use the credit card and then make the necessary transfers to pay off the credit card balance.
Great case in point- I just had to tap MY emergency fund for my 3k+ tax bill. I’m sure glad I have one- I wasn’t expecting to owe so much!
For me, my emergency fund is a catch all for rainy day spending, emergenies, and yearly expense items. I budget out the fund with a google doc to help keep track of what I have it in.
This was just the article I was hoping would come back up. The idea of an emergency fund is a crucial part of any financial plan, which is why I started mine now instead of waiting to become debt free. I feel that an emergency can be a real set back to my debt elimination program if I don’t prepare to be able to weather it should it occur before the debt is gone.
I use a multi-tiered emergency fund made up of emergency cash-on-hand at home as tier I. I use my credit union accounts for tier II, which is made up of 6 savings certificates (basically, CDs) each with a 6 month maturity laddered (i.e. purchased) one month apart, a checking account and savings account. The savings certificates ensure that I can get a high interest on money that I most likely will not use except in the most dire of emergencies that cannot be handled by my cash-on-hand and the savings and checking account. Soon, I will implement tier III, which will be 12 Series I savings bonds laddered (i.e. purchased) one month apart. These will only come into play if the first two tiers aren’t enough, and they will grow to full maturity tax-deferred and interest rate indexed until used. I think I have a good mix of very liquid and not so very liquid stores for the money.
Great post JD - from small seeds grow great things! It is only since starting to read pf blogs and really get ourselves organised that we have managed to get our Emergency Fund to $8000 - since Nov 07. I have been overwhelmingly, delightedly amazed we could do so well in such a short time….and acutely ashamed that we were spending those funds willy nilly beforehand. But, is all good now..although takes a little while to ‘drop’ some of the worry…for example, things were a bit rocky at work and I started to fret until I thought ‘Doh, you have 3/4 months worth of emergency money - that is almost probably enough time to find a new job’…it is has been a very comforting revelation.
Thankyou again JD for your candid and refreshing posts - I wonder how many lightbulbs your words turn on? They have certainly provided me with a lot of motivation and changed the way my family lives today..and more importantly, tomorrow. Thankyou.
Lorraine
Very good post. but I’m just curious - why ING and not HSBC. HSBC has a 3.5% APY rate I believe, and ING is at 3.0%.
The only reason I ask is because I have an high-yield online savings account with HSBC, but lately since I’ve heard so much about ING and their subaccounts, I’m really tempted to switch. However, I’ve also been warned to limit the numbers of accounts I open for security reasons (having more accounts = more opportunities to have my identity stolen).
Why not HSBC? It seems like they have a pretty high rate of fraud.
http://consumerist.com/search/HSBC/
I adore my emergency fund! It’s as if I was being followed around by a group of people holding a basket lined with cotton, for me to fall back into should I trip. I love that security.
I dumped everything into mine for a few months, so since starting a few months ago i have $2000. And the best thing is, I’ve never saved anything before, and I’ve already made $12 in interest!! If I leave the savings at that quantity (and I won’t, I plan to save for other short-term goals on top of it) I’ll make $100 a year in interest! JOY!
I can’t stress the importance of the emergency fund. Specially for people starting to pay off their debt, and seeking financial independence.
The peace of mind you get knowing that money won’t be an issue in case of an emergency is priceless. About three weeks ago, my car broke down. For the first time I didn’t feel a sense of panic during an emergency. In fact, it didn’t feel like one. Instead it felt like a slight nuisance. I love the emergency fund!!
Great post. And great blog in general. I only found you a couple weeks ago, but I love your style.
My husband and I are both savers, which cuts down a lot on the money arguments.
We found out a few years ago just how important an emergency fund can be. Four months after our daughter was born, while I was still on maternity leave and not earning any money, my husband was laid off for the first time in his career.
We didn’t really see it coming, and it took a nerve-wracking 4.5 months for him to get a new job. During that time, our washing machine broke and had to be replaced and my best friend died at age 37 and we flew from PDX to Chicago for her memorial service.
We also had to pay $1200 a month to keep our health insurance via COBRA.
And although we cut it close, we managed to do all of that without having to dip into longterm savings after cutting our budget to its barest minimum.
(And it worked out well in hindsight. Not only did my husband get to spend WAY more time than he would have with our daughter during her infancy, but he ended up with a better job and a significantly higher salary. I just wish we’d been able to spend those 4.5 months enjoying them without the worry of how long it would take to find a job.)
Needless to say, the first thing we did once he was employed again was build that fund back up, and we continue to add to it since our expenses are increasing as our daughter, now 3.5, starts preschool.
This is great advice. I only recently started saving (age 30) and actively paying down my credit card debt. I just opened an ING account with a bonus check and can’t wait to get my CC debt paid down.
I have us on a 12 month spending plan to pay it all off. It is amazing when you star looking at budgeting where all your money goes. I know we have been wasting too much for too long.
Thanks for the great advice and keep it coming.
“I need to increase my deductibles”
From my experience, the nice thing about increasing deductibles is when you slide off the road into a mailbox 3 months after doubling the deductible, the insurance company doesn’t spend much time looking at you as a possible fraudster
Ha ha, my credit union pays 1.10% on my share account.
Which is still not wonderful, but as I understand it, most banks pay less than one percent interest on regular savings accounts, and obviously at least some credit unions do as well, so I wound up with a good’un. At this point I’m more worried about getting the emergency fund together than about what interest rate it’s paying, as I don’t use my savings account for an investment account. I think I should worry more about interest rates when it comes time to invest. But your mileage may vary.
Oh, and… I don’t know that I really had it drilled into my head about savings when I was growing up; I think my parents fell somewhere in between on the continuum. The last savings account I had as a kid–we had to change banks sometimes because we were a military family–I opened it with my stepmom in 1989. I didn’t close it until eleven years later. 1989 was my first year of high school; after I left home I sent money to that account periodically and at one point I had amassed over two thousand dollars. Then my then-husband decided I was an idiot to squirrel money away when we had credit card debt and demanded that I take the money out and pay bills with it. Thank goodness my stepmom had sense to not completely drain the account. And I learned a harsh lesson: even married people need their “own” money that has nothing to do with the other spouse. Because if nothing else you need some kind of backup plan in case the two of you get completely turned around about your financial approach and wind up in trouble.
Oh, and sorry for the multiple comments. Dunno if I have said it here before or not, but ING is picky about what customers they take on and keep. I got dropped with a letter from them stating that they had run a credit check on me and would not do further business with me because my credit was too bad. I knew my credit was bad, but that was the first time a bank ever told me to get lost over a savings account, which has nothing to do with credit whatsoever. I don’t think I’ll go back to them even when I improve mine.
I am 29 years old and have 2 jobs. I have a 6 month plan to pay off all my debt and am taking every advice I can on how to save money. Your situation is just like mine, as my parents too have a really hard time saving money. I still have a lot of questions, such as where to put saved money eg. mutual funds, CD’s??? I am working on saving 17,000 in 10 months and pray to God I can keep these 2 jobs as long as I live as they are both great jobs and they take up most of my time, leaving me little time to spend.
Actually, I need a little financial advice. My mother will be retiring as a nurse by the end of the year. Is there a chance to purchase a home with a Downpayment of 15,000. I have tld my parents that I will put the downpayment along with the closing costs for a condo, as long as they pay the rest of the mortgage.
Chris,
I see that nobody knows an answer to your questions. It is very difficult what you are trying to do, and I wish I could give you an answer, but I really do not know anything about this. I am extremeley new in savings, and I just opened 2 accounts with ING, which pays 3%. If someone needs a referral code to win $25 when opening an account, with a minimum deposit of $250, send me an email at madalinax@hotmail.com. And I will gain $10. Everyone happy!
Chris, once again, good luck and do not give up!