By Linda G Stubblefield October 8, 2020
What do you do when your refrigerator dies? If your roof springs a leak? If your brakes go out on your car? Many people depend on credit cards to bail them out of tight situations. They assume they can pay for their emergency over time.
Take Rosamond, for instance. Like many people, she had been laid off during the pandemic. Monthly bills were hard enough to handle, but on top of everything, she had accumulated $17,000 in credit card debt. Now the monthly payments were getting impossible to handle. She heard she could make a withdrawal from her 401k without penalties if she paid it back in three years. That sounded good to Rosamond! Done. Whew! It felt so good to be out of debt! She couldn’t believe the relief she felt!
But just as she got her feet under her, started back to work part-time– Uh oh. Her newly licensed son had a fender-bender. No one was hurt but the fender. Now she had a $2,200 bill from the auto shop. If she used her insurance, she knew her already high insurance premiums would skyrocket. Where would she get that money for the car repair? Rosamond turned back to the credit card. And back in debt.
There is a secret to staying out of debt. It is the time revered Emergency Fund.
Life is uncertain. We know that. In acknowledgement of that fact, we prepare in advance. Every time you get paid, every time money comes to you, a piece of it should go to your emergency fund. “Gather ye acorns while ye may,” just as the old saying goes. Prepare in summer for the winter ahead. Emergency funds keep us from having to use credit when life happens. You are prepared for the unexpected life. You are the squirrel in autumn, bagging extra nuts before winter.
How much is enough? Like most things, the answer is, “It depends.” Most people keep too little: they are spending too much and depending on credit for emergencies. Others keep way too much, because they feel insecure about their money management.
Here are my recommendations:
- If you are a 2-income family, with fairly secure jobs, then 3 months of your expenses in a liquid account will do it. (If your Total Expenses are $80,000 per year, divide by 12 months and multiply by 3 months, you should have roughly $20,000 in a savings account or in a money market.)
- If you are single (or you are married but incomes are not secure) 6 months of your Total Expenses are best for you. (Divide your annual expenses by 12 and multiply by 6.)
- Cash in Retirement –If you are retired, things are a bit different. I call it a Spending Fund, rather than an Emergency Fund, since there is no job to lose, and you are already including in your budget items like extra medical expenses, house repairs, and new car purchase. Your spending fund should equal 1-3 years of annual expenses.
Debt is the quintessential threat to our safety. It requires constant feeding from our income and becomes ferocious if kept waiting. The Emergency Fund is a time-honored tool for keeping us safe. If it is not needed, it stands by as a comfort. This is a perfect time to acknowledge its importance and unlock the secret to staying out of debt.