Experts have been touting the importance of having an emergency fund since Moses was a lad. So why is it that so many people still don't have enough (or any?) money set aside just in case? Reasons and rationales abound.
“I'm paying off my debt. That's the most important thing.”
With the amount of debt people are buried in, it's no wonder people want to get rid of it as fast as they can. But having a single focus is never a good way to create balance. Money in the bank gives you options — ways to deal — so that you can stay on track with debt repayment even when bad things happen.
Having no cash at the ready means you'll no doubt be forced to use your credit to deal with a broken furnace, unexpected medical bills, or replacing that tire you blew on the highway. Accessible cash means you can keep to your debt-repayment plan and deal with whatever crisis — large or small — that has come knocking on your door.
“I can't see the point of letting money sit earning next to nothing.”
While it can be a really sad thing to watch thousands of dollars languishing in a savings account, return isn't the priority with an emergency fund. Access is. Stick that money into the market and it may not be there just when you need it most. Stick it in a high-interest savings account and while you may be irked by the pittance you're earning in interest, the emergency fund will be at the ready when you hit the wall. The point is to have some wiggle room when the unexpected happens.
“I have $1,000. That's enough.”
$1,000 may be enough of an emergency fund if you live under a rock. Yes, you'll need less of a buffer if your home is paid for, you have no debt, you walk everywhere you go, and you're happy eating ketchup soup three nights a week. If you want a realistic emergency fund — one that actually gets you though the rough — figure our your monthly essential expenses and multiply by six. That's how much you need.
Unemployment insurance may help fill the gap if you lose your job, but it doesn't go far. And unemployment isn't the worst emergency you may face. Get sick and watch your money evaporate. Even if you have good health and disability insurance plans, your cash flow will still take a kicking until your benefits click on.
“Who needs an emergency fund when you can use a line of credit?”
The people telling us to get an LOC is an emergency fund are the same people who let us buy houses without enough money down, offered us ways to satisfy all your whims while spending money we hadn't yet earned, and continually raised our limits until many of us had enough debt to bury an elephant.
A line of credit is not an emergency fund…it is debt waiting to happen. If you hit a wall and end up racking up tens of thousands in debt on an LOC, how was that diverting disaster?
The Ways-and-Means Fund
Perhaps the problem with the whole emergency fund thing is that people don't like to think they'll have to deal with “emergencies.” It's not unlike the folks who won't make a Will because they don't want to contemplate their demise, or who won't buy disability insurance because they can't imagine becoming disabled.
Maybe we're just calling it by the wrong name. The whole idea of having to deal with “emergencies” can be a real downer. Maybe what we need is nomenclature that sounds far more proactive and positive. We'll stop predicting disaster and instead focus on the fact that when you have money at the ready, you also have ways and means to deal with whatever life pitches at you.
Hmmm…a Ways-and-Means Fund…cash in the bank that gives us the means so we can figure out ways of dealing with life's lumps. Your son breaks his arm playing in the yard, and you have the means — the money — you need to take a day off work, get him to the hospital, and cope in whatever other ways you must. Your partner is downsized and you have the means to pay the mortgage and keep food on the table until he finds new ways of bringing home the bacon. You bang up your car, watch your shingles blow off in a wind-storm, or find yourself in the throes of a divorce, and you have the means to keep the financial boat afloat while you find ways to cope with all the other stress in your life.
Convinced that having The Means offers you more Ways of smoothing out life's bumps? Now it's just a matter of coming up with the dough. It takes effort to knead intent into action.
The best way to create your Ways-and-Means Fund is to set up an automatic deduction from your regular account to a high-interest savings account. If you don't have much to save, it doesn't matter — the important thing is just to start…to convert your intent into action. As long as you haven't started, you're not creating the means for dealing with what life will inevitably throw at you. Commit $25 per pay to your Ways-and-Means Fund. Once you've begun, you're on your way and then it only becomes a matter of how to boost the amount you're setting aside to grow your stash of cash.
Most people have expenses they can trim to boost the money going to their Ways-and-Means Fund. Do you buy coffee every day on the way to work? Calculate how much you're spending, cut it in half, and send the difference to your Ways-and-Means Fund. Smoke? If you smoked half as much, how much would you be able to sock away? Pick up the latest magazine at the checkout counter?
Subscribe to premium cable? Go out for a drink with your friends after work? Buy your lunch at work? Pick up your favorite “stuff” whenever it's on sale even though you already have 30 pairs of shoes, white shirts, handbags, DVDs, name your vice here. How quickly could you build your Ways-and-Means Fund by focusing on being safe as opposed to being satiated?
If you're determined to keep all your small indulgences, try the tit-for-tat approach to building your Ways-and-Means Fund. Each time you satisfy a Want, contribute an equal amount to your Ways-and-Means Fund. Not only will it make you really think about whether you're going to spend the money — in essence whatever you buy is going to cost your cash flow twice as much — you'll be giving yourself options for the future while you enjoy yourself today.
Author: Gail Vaz-Oxlade
Gail Vaz-Oxlade is the host of the popular Til Debt Do U$ Part on CNBC. Gail is a columnist for MoneySense, Chatelaine, and Zoomer Magazine and blogs daily at her website, where she also offers terrific tools people can use to dig themselves out of the hole. Gail's latest book is Debt-Free Forever.