emergency fund

Have A Fallback Plan In The Event Of An Emergency

I’m a big believer that you should have money available in the event of an unexpected financial emergency.  Unplanned costs can take many forms.  A medical emergency can present thousands of dollars in costs in one visit to the hospital.  If your furnace or air conditioner goes out and the system needs to be replaced, you’ll be looking at big costs.

Emergencies don’t always present themselves only in the forms of costs.  Cash flow can also present an issue.  If your expenses stay the same, but the amount of money you bring in suddenly gets slashed, you can find yourself in trouble.

OLYMPUS DIGITAL CAMERAI believe that having an emergency fund can help address many of these issues, but there may be times where you need to go above and beyond what you have saved for such emergencies.  It’s prudent to have a plan in place in the event that you need cash even after your emergency fund has been depleted. Thinking about it now can make things a lot less stressful later.

Cutting expenses is a big option.  If your bills go up or your income goes down, look at reducing your cash flow.  Things that you may consider necessities may not be once you really find yourself in a crunch.  Think about reducing or eliminating your cable bill.  Cut your internet speed to the lowest available.  Make sure you are paying the least possible for your cell phone plan.  Cut or eliminate eating out.  All of these things will reduce the amount of money you send out the door each month and can help you pay for that emergency, whatever it is.

Take on additional work.  If you need to make up a cash flow shortage, consider looking at ways to increase your income.  Taking on odd jobs can give you money here and there.  If you’re handy, try to see if you can get some simple repair or fix-it work.  If you’re great with computers, try to put that to use.  Working a full time job, then taking on more work after isn’t an ideal situation in the long run, but it can surely help button up your finances in the short term.

Look at loans.  If you really need money, think about taking on a loan.  The biggest thing to consider before asking for a loan or applying for a loan is to have a clear plan on how you would pay it back.  The last thing you want to do is put yourself in a position where you get access to cash, but then don’t have the means to pay it back.  You can ask family or friends, though this can be uncomfortable and they may say no, in which case you should not be offended or let it jeopardize your relationship.  Having a plan to pay back the loan will help.

The biggest takeaway here is to understand that an emergency fund, no matter how well stocked, does not provide assurances of guarantees.  It’s important to have an emergency fund as a buffer to unexpected costs, but it’s just as important to plan beyond that.

Pay Debt Away But Keep New Debt At Bay

One of the things I love most about being a personal finance blogger is reading stories about other people who have reduced or eliminated their debt.

Our debt is pretty simple:

  • A mortgage – We re-financed our original 30 year mortgage (set to pay off in 2037) with a 15-year mortgage in late 2011.  This will put us on pace to pay that off in 2026.
  • A student loan – My wife has one outstanding student loan.  It is a private loan with a rate lock of just over 2% and a payment under $100 per month.  It’d be nice to pay this off early but we’re not changing our current strategy to do so.  Additional cash flow would have to open up.
  • Credit cards – None.  We use credit cards simply to earn cash back rewards
  • Car – None. We have two cars, both fully paid off.

It’s great as I see a lot of bloggers write about paying down debt, paying off debt, or discussing their personal debt payment strategies.  For the most part, they’re usually pretty good.

However, there is one thing that I usually see left off, and that’s to have a ‘No New Debt’ provision, and a plan to reach it.

If you start off with $100,000 in debt, work hard, and pay off half of it, that’s awesome!  What if you have $10,000 in debt, and you pay it all off.  That’s great, too!

And, with most debt payment stories, that’s often the ‘end’, so to speak.

What it doesn’t address is to make sure that number never goes higher.  In other words, if you pay off half of that $100,000 debt, you should make sure to do everything possible to avoid having that number go higher.

If you pay your debt off, congrats, but resist the urge to go splurge, financing a new car, vacation, boat, or whatever that’s going to get you right back in debt.

In other words, here’s my debt payment plan that you should adjust every month.

  1. Calculate your starting debt
  2. Make your payments
  3. Calculate your new debt total (it should be lower now)
  4. Set the new debt total as your debt ceiling

That’s right, every month you need to make sure that you set a goal to make your current total your maximum.

What that means, though, is that your debt payment strategy should plan for this.  I have read many articles on whether it’s advisable to save or to have an emergency fund if you are paying off debt.  The answer, based on my advice is: It depends.

How?

Well, if you are in a position where you are risk of emergencies, then yes, you should have an emergency fund.  Do you drive an old car that’s prone to breakdowns?  Do you live in an old house with a furnace or boiler 15 years past it’s expected date?  If these or something like these are in place, then you need an emergency fund.  If you live in an apartment and drive a bike to work, you might not need this as much.

Same goes with savings goals.  If you buy a house and you know you’ll need a new roof in 5-10 years, then start saving along with paying debt.  Otherwise, when that roof goes and you’ve paid every dollar toward debt, you’re going to have nothing left to pay for that new roof.  As good as it is to have paid off more debt, you’ll be violating your debt ceiling’ rule.

That’s not good.

So, make sure your strategy is complete, and if you focus 100% on paying debt, you have the best of intentions but you’re leaving a blind spot, and just like with driving, those can lead to peril in the blink of an eye.

Readers, what is your strategy to pay away and keep new debt at bay?

Is Our Emergency Fund Redundant?

For years, I’ve kept an emergency fund.  This is split between an ING Direct (soon to be Capital One Direct) and Ally Demand Notes account.

Along with the emergency fund, we have money set aside for other savings goals.   These include things like:

  • New Car – Eventually we’ll need to replace one or both of our cars and this would be so that we could avoid or reduce a monthly payment obligation.  This should probably, in reality, say ‘Car Replacement’ since new car implies that we would buy a brand new one, which in all likelihood is not something we would probably do.
  • Home Repairs – Right now we have a good chunk of money in here but will probably be depleted next year when we have to replace the roof on our home
  • Car Repairs – A fund that I keep for things like brake jobs, new tires, and if we would ever have to pay a deductible if there was an accident
  • Cashback Rewards – When we cash in our checks from our cashback reward credit cards, we stash the money here.  So far, both of the flat screen TVs we’ve bought have been funded entirely out of this account.
  • Next Years Tax Refund – When we make withholding adjustments to avoid giving the government a big free loan, I stick most of the money here, and then we divvy it out come tax refund time next year.  This is pretty boring and generally goes to bulk up most of the other accounts here.

There are a few other categories here, but I guess after thinking about it awhile, I’m wondering if our emergency fund is entirely or partially redundant.  It seems to me that if there were an emergency, the funds could be used from other allocations to cover the immediate needs that would be required.

Let’s look at a few potential emergency situations which could require access to these funds:

Job Loss

Say that I lost my job. This would take away all income from our family.  If this were to happen, we could tap into the fund for a replacement car to cover bills until I found a new job.  The reason I would consider this is because if I have just lost my job, there is no way I’m going to be putting any thought into buying a new car, so wouldn’t that, in a sense, free up that money for immediate use?

Medical Emergency

The same goes with a medical emergency that required a large payment.  If one of us were to get sick or severely injured and have a large medical bill, chances are your entire focus is going to change anyways.  The ‘new car’ fund could again be looked at as that wouldn’t be an immediate need.  Buying gadgets and such with the money in our cashback rewards allocation would no longer be a priority and that money could be put toward the purpose of covering us in the event of an emergency.

The Car Gets Totaled

If we were to get into an automobile accident to the point where the car would need to be replaced, the insurance company would likely give us a check for the value of the car less our deductible.  We could use this to buy a similar year and model type car, or use the money in our new car fund to buy a newer car.  Either way, unless there was an associated medical or legal cost involved, the subcategories that we have allocated would seem to cover most of the potential expenses here.

To summarize, if we were to change direction here, we wouldn’t be eliminating our emergency fund, we would just be giving multiple purposes to the funds that we have allocated for other items, keeping those allocations the same, but adding a secondary ‘emergency’ fund to many of the categories.

Allocation

If we were to take these funds out of ‘dedicated’ emergency duty, the question would be what we would do with the money.  We could go out and take a great big vacation or do a big project around the house or find some other way to spend it…but if you know me well enough, you know none of those things are going to happen. Spending the money is not an option.

We would look at doing something along the lines of:

  • Investing it in a standard brokerage – This would give greater opportunity to increase the value of these funds (of course increasing the risk of losing them, as well).  It would also be pretty easy to access these funds should the need arise.  We could manage the money ourselves or see about setting something up with a financial adviser.
  • Investing it in a retirement account – We could boost our retirement savings with this money.  This would keep our net worth the same, but would reduce our cash liquidity, and the rules surrounding retirement accounts would make it so that these funds would be pretty much inaccessible for many years.  There could be tax advantages or other reasons where this would make sense.
  • Pay off debt – The only debt we have is our mortgage and one remaining student loan.  The student loan could be paid off in full, which would free up around $100 per month.  This could, in essence, be used to re-build the emergency fund over time if I wanted to stay somewhat conservative, or that money could be funneled toward investment, retirement, or saving for some of the other goals I already mentioned.

I’m a pretty conservative person when it comes to our money, but at the same time, I don’t want to have money that’s sitting around doing not much of anything if there are opportunities to grow it faster.  Back in the day when the rates were 5-6%, you could justify having this money sitting there, but with the average rate between our two accounts at barely over 1%, it’s probably not even holding its value over time if you consider the effect of inflation.

Readers, I would love your opinion?  Do I keep things as is, make the other funding categories dual purpose or do you have some other potential approach that I haven’t yet considered?  I’m always up for new ways of thinking.