This entry was posted on Friday, August 8th, 2008 at 8:43 pm and is filed under Credit Cards, Debt, Planning, Retirement, Saving and Investing, Social Psychology. Both comments and pings are currently closed.
One of the keys to spending less than you earn and staying out of debt is having an emergency fund. Personal finance gurus like Dave Ramsey suggest that your very first step down the path to financial freedom is to put $1000 into a designated emergency fund. This should be done before beginning any kind of aggressive debt pay down.
We created our first official emergency fund just a couple of years ago. Before that we just tried to keep some amount of extra money available in our money market account. I don’t remember specifically how we created the emergency fund, aside from just diverting some debt reduction money towards this purpose.
To separate the emergency fund from our everyday money, I created a CD ladder by dividing the money in the fund into 5 equal parts and buying 1, 2, 3, 4, and 5 year CDs. Since then, every time a CD matures, I roll it into a new 5 year CD. This generally allows us to enjoy the highest interest rates available while still frequently providing us with liquidity to some portion of our money. I like using CDs in this way because it places a penalty on the withdrawal of the money, which makes it far less likely that we will raid this fund for anything less than a true emergency. The penalty that we would have to pay to access the money is small compared to the security that the fund provides.
So what’s the problem? When we created the emergency fund, we did so by contributing the minimum amount allowed by our bank to each CD. Since that time, we have added some additional money to each CD when it matured and rolled over, but the overall amount of money currently available for an emergency amounts to only 2.3 times our basic monthly expenses.
On the one hand, we’ve got more than the recommended amount while still paying down debts. On the other hand, we don’t have the recommended minimum of 3 months of expense for a true emergency fund, and nowhere near the 6+ months that’s really advisable, especially in a soft economy. We’re not as worried as others might be, however, since ScrapperMom is working part time, and in the event I lost or left my job, she could go to full time immediately and her salary alone would cover our needs. Nonetheless, it may not always be possible for her to work given that her first job is that of stay-at-home mommy. It’s time for us to get serious again about an emergency fund.
So where do we go from here? Well, since our Roth IRAs are fully funded for the year, that is one possible source of funding for a larger emergency fund. We would like to save more towards retirement this year, however. Another source is the extra money that we have been devoting to the aggressive reduction of the balance on our car loan. I believe that this is one of the real tricks to effective personal finance: attempting to meet several goals simultaneously. In this case, we want to increase our available emergency funds, save as much as possible for retirement, and pay off our car loan and existing business credit card. The bottom line is that we will have to compromise something to meet all of these goals, and it’s not clear to me what that should be yet.
How is your emergency fund doing? What would you sacrifice in our case — retirement savings or debt reduction? Perhaps a little of both? Or would you be comfortable for now if you were in our shoes? We’d love to hear your comments below!