My son and I had a conversation recently about planning for the inevitable "bump in the road" that occurs in life. I shared with him how important it is to be prepared. I told him that, even years ago, we would set aside a small amount of money as an "emergency fund" just in case we needed it. His comment back to me was very telling indeed. He said "yeah dad, you can do that because you earn a lot more money than I do". Wow, what a wake-up call!
Having money is not the issue. The real issue is what you're doing with what you currently have. My son's comment really is the core argument most people have with setting up a financial plan in the first place. Folks believe that because they have little money, they do not need to account for it. Nothing could be further from the truth.
Let's define what an emergency fund is. An emergency fund is an amount of money set aside for emergencies. Pretty simple, huh?! It is not money set aside for vacations. It is not money to cover an investment opportunity. It is money set aside for those times when something vital to the family breaks or needs to be repaired immediately and there is not enough in the budget category (i.e. home repair) to cover the situation. Every family should have "X" amount of money set aside each month to cover the basics (home repairs, clothing, car repairs, etc.). Normal repairs and maintenance should come out of the monthly budget allotments. If that money is not used one month, it is added to the next month. It continually gets larger until a need comes up and some is withdrawn.
The whole purpose of an emergency fund is to have a pool of money that can be used if an emergency situation arises. Use this money to fix or repair something to avoid going (deeper) into debt. If the washing machine suddenly quits working, then go to your home repair account and try to resolve the problem using those funds. Honestly, many washing machines can be serviced by anyone who can handle a wrench and read a do-it-yourself manual. A motor may cost $75 if you do it yourself, or a new belt may cost $15 and take 30 minutes to fix. Whatever the situation, deal with it quickly, then get right back to eliminating your debt. If you do tap your emergency fund, replenish it as quickly as possible before returning to your focused debt elimination process.
Having money is not the issue. The real issue is what you're doing with what you currently have. My son's comment really is the core argument most people have with setting up a financial plan in the first place. Folks believe that because they have little money, they do not need to account for it. Nothing could be further from the truth.
Let's define what an emergency fund is. An emergency fund is an amount of money set aside for emergencies. Pretty simple, huh?! It is not money set aside for vacations. It is not money to cover an investment opportunity. It is money set aside for those times when something vital to the family breaks or needs to be repaired immediately and there is not enough in the budget category (i.e. home repair) to cover the situation. Every family should have "X" amount of money set aside each month to cover the basics (home repairs, clothing, car repairs, etc.). Normal repairs and maintenance should come out of the monthly budget allotments. If that money is not used one month, it is added to the next month. It continually gets larger until a need comes up and some is withdrawn.
The whole purpose of an emergency fund is to have a pool of money that can be used if an emergency situation arises. Use this money to fix or repair something to avoid going (deeper) into debt. If the washing machine suddenly quits working, then go to your home repair account and try to resolve the problem using those funds. Honestly, many washing machines can be serviced by anyone who can handle a wrench and read a do-it-yourself manual. A motor may cost $75 if you do it yourself, or a new belt may cost $15 and take 30 minutes to fix. Whatever the situation, deal with it quickly, then get right back to eliminating your debt. If you do tap your emergency fund, replenish it as quickly as possible before returning to your focused debt elimination process.
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We've put together a series of Free Reports which are full of tips to help you begin the debt elimination process. Simply give us your first name and valid e-mail address below. Don't worry, we despise e-mail spamming just as much as you do! We'll keep your information 100% confidential and won't share, sell, or exchange it with anyone... we give you our word!
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We had a refrigerator once that began sounding like a thrashing machine. It got so loud that my wife could not hear my voice when I called her at home. We got rid of that machine and bought a used one for a fraction of what a new one cost using our emergency fund.
We do not advocate setting a huge amount aside for an emergency fund, but it is prudent to set some aside right away. We've worked with people who use their credit card as their emergency fund. What that really means is that they routinely declared an emergency and used the card if they need money for something. That is not what we're talking about! Some debt counselors tell people to set aside somewhere between three and twelve months worth of expenses before beginning any sort of debt elimination program. We disagree with this, and encourage families to set aside no more than one thousand dollars. Here's why:
The whole idea of debt elimination is to attack and kill off the debt just as fast as possible. To do this, all available funds must be directed at the debt, one at a time, until it is gone. If money is diverted to fill an emergency fund, then those dollars cannot go to pay off outstanding debt, which is accruing interest daily on unpaid principal. Most people can fund their $1000.00 emergency fund in just a few months, but setting aside more would be overwhelming. They would look at the size of the mountain (trying to fund the huge emergency fund) they are facing and decide to not even try to climb it. It is much better to quickly establish the thousand dollar emergency fund, then redirect their available funds at the debt.
If a problem comes up that requires money outside of the monthly budget, simply take some of the dollars being used to retire the debt and redirect it to the need. After the situation is resolved, go right back to attacking the debt the next month. Stay on track, divert when absolutely necessary for a month, then get right back on track again. Very few situations will ever come up that need to actually tap the emergency fund. It is even rarer to need more money than the emergency fund contains.
When your debt is completely paid off, if you wish, redirect your monthly dollar stream into a larger pool of money for your emergency fund. Be sure to keep it liquid (not tied up in stocks or bonds) so you can access it quickly if needed. Put the rest of your money into investments that will get a nice rate of return. Having "idle money" sitting around, not working for you, is foolish. Be wise with your financial decisions.
In conclusion, the emergency fund is a necessary component of a larger overall financial plan everyone should have. It provides a resource that can be tapped if a true need comes up that monthly budgets, and extra monthly available funds cannot adequately cover. It is not the best use of your money to redirect lots of dollars into a huge emergency fund early on. It is much better to set up manageable budgets everyone can live with than to continually tap the emergency fund because of planning shortfalls. It's your money, so make sure every dollar is allocated so that it is working hard for you, not someone else.
We do not advocate setting a huge amount aside for an emergency fund, but it is prudent to set some aside right away. We've worked with people who use their credit card as their emergency fund. What that really means is that they routinely declared an emergency and used the card if they need money for something. That is not what we're talking about! Some debt counselors tell people to set aside somewhere between three and twelve months worth of expenses before beginning any sort of debt elimination program. We disagree with this, and encourage families to set aside no more than one thousand dollars. Here's why:
The whole idea of debt elimination is to attack and kill off the debt just as fast as possible. To do this, all available funds must be directed at the debt, one at a time, until it is gone. If money is diverted to fill an emergency fund, then those dollars cannot go to pay off outstanding debt, which is accruing interest daily on unpaid principal. Most people can fund their $1000.00 emergency fund in just a few months, but setting aside more would be overwhelming. They would look at the size of the mountain (trying to fund the huge emergency fund) they are facing and decide to not even try to climb it. It is much better to quickly establish the thousand dollar emergency fund, then redirect their available funds at the debt.
If a problem comes up that requires money outside of the monthly budget, simply take some of the dollars being used to retire the debt and redirect it to the need. After the situation is resolved, go right back to attacking the debt the next month. Stay on track, divert when absolutely necessary for a month, then get right back on track again. Very few situations will ever come up that need to actually tap the emergency fund. It is even rarer to need more money than the emergency fund contains.
When your debt is completely paid off, if you wish, redirect your monthly dollar stream into a larger pool of money for your emergency fund. Be sure to keep it liquid (not tied up in stocks or bonds) so you can access it quickly if needed. Put the rest of your money into investments that will get a nice rate of return. Having "idle money" sitting around, not working for you, is foolish. Be wise with your financial decisions.
In conclusion, the emergency fund is a necessary component of a larger overall financial plan everyone should have. It provides a resource that can be tapped if a true need comes up that monthly budgets, and extra monthly available funds cannot adequately cover. It is not the best use of your money to redirect lots of dollars into a huge emergency fund early on. It is much better to set up manageable budgets everyone can live with than to continually tap the emergency fund because of planning shortfalls. It's your money, so make sure every dollar is allocated so that it is working hard for you, not someone else.
About The Author
Rick Boynton and his wife Linda pioneered the "radical approach" to debt elimination. While many debt counselors advocate the wife working outside the home, the Boyntons show how the "stay-at-home-mother" actually multiplies, or leverages the husband's income. Together, they wrote a book called "Radical Debt Elimination", which leads families step-by-step through the complete debt elimination process. Not only does this book deal with the obvious financial problems, but it also addresses the deeper issues that caused the problems in the first place. Find out more by going to www.radicaldebtelimination.com