Thursday, August 20, 2009

Emergency Fund

“Save for a rainy day”. Everyone has heard it but few do it.

For many years my emergency fund was my credit card. When – not if – something bad happened I charged what was necessary on my plastic and then tried to pay for it over the next few months.

But when you spend pretty much what you make every month, paying off a credit card is difficult. Even making those pesky “minimum payments” takes a bite out of your “budget”. And consistently making minimum payments is a sure-fire way to stay in debt forever.

Worse, Mr Murphy invokes his infamous law and more financial emergencies (i.e. life) happen before you’ve paid off the first “emergency”. Your credit card bill grows and your ability to pay it off shrinks.

The best way out of this mess is to avoid it. Pay Mr Murphy before he invokes his law. Squeeze your budget for the “minimum payment” money before it must to be paid to the bank. If you pay Mr Murphy by putting that money in a savings account every payday then, when Murphy’s Law is invoked for you, the bill will already be paid. All you have to do is move the money from the savings account to the people who provide the products or services needed to correct the problem.

Note that it is now a “problem” not an “emergency”.

Financial planners recommend that you save enough money in an emergency fund to cover your expenses for three to six months. This is supposed to sustain you after a job loss until you land another job. That’s a good target although I think twelve months of expenses is an even better target. But whatever the target, don’t let the size of the number discourage you from starting.

Any positive amount is better than zero. Mr Murphy’s law covers a lot more than job losses. $500 in an emergency fund could go a long way toward repairing your car so you can get to work next week.

The key is to systematically put some amount away for Mr Murphy every payday. The more you accumulate the more you insulate yourself from the effects of Murphy’s Law.

Mr Murphy WILL BE PAID. Life happens! The only open questions are; (1) Will you live your life or will life happen to you? (2) Will the bank pay you or will you pay the bank?

You determine the answers by choosing – or not – to create and grow an emergency fund.

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