This was originally published on Monday, August 18, 2014, in the Pacific Daily News. Click here to subscribe to the PDN.
Question: My car recently underwent some major repairs. I do not live paycheck to paycheck, but when unforeseen occurrences like this happen, it always seems to put me in a position of hardship. What should I do to ensure that if a really major occurrence happens, it does not financially hurt me?
Answer: There is a saying that “A map helps us see the destination. A plan reveals how you get there.” If your goal is to be prepared for unforeseen financial emergencies then your plan should be to create an emergency fund. An emergency fund is money that is set aside just for emergencies. A 2011 survey conducted by the National Foundation for Credit Counseling has concluded that 64 percent of Americans do not have a thousand dollars on hand in the event of an emergency. Not having an emergency fund could add unnecessary stress to an already stressful situation. A solid emergency fund is one of the most vital tools in growing and filling monetary security. No matter how well you plan, bad things happen from time to time.
Your emergency fund should not be used for buying a new 60-inch flat screen TV, or to go on vacation, or to remodel your kitchen. Money for these types of expenses should come from a separate account created just for that purpose. Instead, your emergency fund should be money that is stashed away for handling emergencies. It could be used to fix your car, for medical bills, or as rent if you lose your job. Use a bank account that is separate from your other financial accounts. If they are linked together, you could be tempted to make transfers from your emergency account to another. Do not carry a debit card or checks linked to the account; this will force you to reconsider if this is an actual emergency.
Your emergency fund should be highly liquid. A simple savings account will do. Don’t think of it as an investment. Usually higher interest rates come with higher risks. Your emergency fund should be placed in an account with little to no risk. Market accounts or time certificates could penalize or prohibit you from making withdrawals. In fact, you may end up paying penalties on the money you withdraw.
How much you put aside depends on your income and your expenses. There is no right amount, so do what is comfortable for you. Some experts say that you should save at least three months of your income set aside for emergencies. You may not reach that goal right away. Start off small and build up to it. When goals are too lofty and hard to obtain, you may become frustrated. If goals are small and attainable, you are more likely to continue with that goal. Start by setting a goal for the month then two months and so on.
Once you set your goal, include it in your budget. You should contribute to it regularly. Think of it as another bill such as your rent, power or telephone. Once you pay for those, pay into your emergency fund. Payments can be made as an allotment from your paycheck or from another account. If the money is automatically transferred, there are no excuses as to why the money did not get deposited that payday. Being unprepared during uncertain economic times can devastate a family or put one’s financial future at risk. Just remember having something saved up for a rainy day is better than not having anything at all.
Michael Camacho is president and chief executive officer of Personal Finance Center. He has more than 20 years of experience in retail banking and at financial institutions in Guam and Hawaii. If there is a topic you’d like Michael to cover, please email him at email@example.com and read past columns at the Money Matters blog at www.moneymattersguam.wordpress.com.