Building Your Financial House - Your Emergency Fund

Building Your Financial House - Your Emergency Fund

An Emergency Fund is one of your most important tools for keeping your Financial House safe. We saw people being evacuated from their homes this weekend as yet another hurricane approached the Gulf Shore states, many of them waiting on government-provided transportation to a public shelter. Some of these people were interviewed and complained about how long it was taking, how smelly and uncomfortable the facilities were.

If they had built themselves an Emergency Fund as well as repairing their homes after Hurricane Katrina, they would have had a supply of money to get themselves to a comfortable place to wait out the storm. They would have been able to pay for train or airfare to another city to rent a room in a decent motel or hotel. They would have had the money to feed themselves adequately instead of waiting in long lines for whatever the emergency workers can supply. The whole experience would have still been an ordeal, but less traumatic, especially on the children and older people.

These people had no options and may very well return to homes that have suffered storm damage. Additionally, hurricane season has not ended for the year; they may be facing another storm before the end of the season. Another evacuation, more damage to home and property. Many of the people in the affected area have no additional money and resources to restore them to a comfortable life when they return home. Most of these people will return home and have to use whatever savings (often their retirement funds) to rebuild back to what they had before. This will devastate any building they have done on their Financial House because they didn't have a foundation to secure their Financial House to.

With an Emergency Fund, they would be able to return home and start dealing with the damage - getting the carpets cleaned, the debris hauled away from around the house, replacing the broken windows, etc... without having to wait for the insurance company to cut them a check. When the insurance check arrives, they can deposit it back into the Emergency Fund.

Most importantly, they know that where they live is prone to hurricane and flood damage, that there will be expenses associated with this damage that will come up often. They know that this expense will come one day.

Each of us knows that expenses are coming one day. The car will need new tires, the kids will need new clothes, the house will need a new water heater - it is inevitable. Yet, few of us actively prepare for this situation in advance. We get 'surprised' and thrown into money worries just to restore us to our accustomed life style. Often this makes us choose between going without, running up debt or cashing in what little we have saved just to keep in the same place we've been.

Your Emergency Fund is the answer to many of life's little 'surprises'. But how much do you need to have in your Emergency Fund? $50.00? $500.00? $5,000.00?

Many financial advisers and planners will recommend an amount of three to six times your monthly expenses, based on the idea that if you were suddenly out of work, you can manage to get by for three to six months as you looked for a new job. There is an inherent flaw in that logic, if you look closely, but it is recommended for a reason.

If you were suddenly unemployed and had to look for a new job, would your expenses stay the same? The answer is actually "No." Your expenses would increase as you will be traveling to locations to interview for positions, spending money and resources on distributing your updated resume or CV, phone calls to follow up on possibilities and maybe even having to relocate to take a new position. This is all on top of your normal expenses. Three months of expenses suddenly gets eaten up in less than three months.

Ideally, you cut out all non-critical expenses when you got laid off, which is supposed to make your expenses smaller and help stretch that Emergency Fund further. Your cable bill - probably under contract. What's the fee for canceling the contract? Will it make sense to cancel it and pay the fee, or do you need that money for something else? How about the big cell phone contract? The car lease? These are expenses that you are stuck with, for the most part, and you are left trying to reduce your food bill to save money. Additionally, every time you have to pull money out of your rapidly dwindling fund, you are worrying more and more, getting less sleep and possibly getting sick.

So why recommend three to six month's of expenses, if that amount is not adequate? Such a recommendation is for several reasons - it is always written up as a minimum amount, but not really pushed in your meetings with your adviser because it is not an exciting task. It makes little in the way of commissions for the adviser and it will take you a relatively long time. It's also advice that you have been seeing, for free, in a lot of media. Since you are paying your adviser for this financial planning meeting and advice to the tune of $300.00 to $1,500.00, did you want to hear that the first thing you need to do is save $12,000.00 to $21,000.00? That is before you start buying mutual funds and planning your retirement with vacations trips, present for grand kids and a fabulous lifestyle? I didn't think so. To tell you that you need to save three to six months of expenses, then identify those expenses marginally to come up with a figure of $5,000.00 to $10,000.00 and jump right to the fun planning is a better sales tactic.

I'm not say that financial advisers and planners are trying to rip you off or take advantage of you, just that they are making a living by selling you financial products. Having all of your cash go into a cash oriented Emergency Fund pays very little for them. Far better for you to have built your Emergency Fund prior to your first meeting with and adviser or planner so that you can take advantage of their expertise in investing rather than budgeting and saving.

$12,000.00 to $21,000.00 as an Emergency Fund. Sounds like a lot of cash, doesn't it? If your monthly income is $2,000.00 a month, your six month Emergency Fund needs to be $12,000.00. If your monthly income is $3,500.00, you need $21,000.00. The math isn't hard, but it's not uplifting either. Furthermore, saving 10% of your income to reach this amount is going to take about 60 months. That's five years of saving. Anything you do that can increase that amount you are putting into your Emergency Fund will shorten that time.

Now for the good news - with a cash cushion of $12,000.00 (your monthly income being $2,000.00 supposedly) think of the number of emergencies in the last year that you could have handled easily with access to that cash, knowing that you will rebuild your fund back to full?

Having the skill of being able to build an Emergency Fund will give you peace of mind, peace of mind that grows with your Emergency Fund. The secret lies in taking action and building it.