Your First Line Of Defense
By David Berky
Downsizing, rightsizing, forced
retirement, layoffs, firings, outsourcing, and being made redundant.
All could mean the same thing to you:
No, you may not have to declare bankruptcy
or move back in with your parents, but losing your job could put a big dent in
your financial goals and even set you back several years. You may need to live
on your savings or liquidate some of your investments.
If you have no savings or investments you
may have to rely on credit cards and could rack up significant credit card debt.
Then when you find a new job, your expenses may have increased because of the
additional credit card payments.
And the job you eventually find may not
pay as much as the one you lost. So you are now forced to live on less while
your expenses have either continued at the same level or even gone up.
Studies show that the average worker will
have six career changes in his or her lifetime. Not just job changes, but career
So how can you prepare for your own
An emergency fund.
An emergency fund is really just savings.
But it is not savings for a particular item or even an investment for your
future or your retirement. It is your "rainy-day" fund. But unlike insurance
where once you pay your premium, the money is out of your hands, your emergency
fund is yours to keep.
So how much do you need? How can you build
your emergency fund? And where should you keep the money?
The easiest way to figure out how large
your emergency fund should be is to take your current income and multiply it by
the number of months you could be out of work. If you make $3,000 each month and
you want to be prepared for a 6 month "vacation", you will need $18,000.
But obviously saving $18,000 will take
some time. How quickly you want to build your emergency fund depends on how
concerned you may be about your current and future employment prospects.
Saving $100 each month will take you 180
months or 15 years. Saving more each month means you will be protected sooner.
Also consider that during the next 15 years your income may increase and your
expenses usually rise to match your income.
Also consider inflation. (If you own your
home, your house payment may not rise. If you are renting, your rent probably
will.) The cost of food, utilities and taxes also rise over the years. At a 3%
inflation rate after 15 years your $18,000 will only buy $11,400 worth of goods.
A good rule of thumb for saving is to try
to save enough each year to supply you with one month's income. This means you
are saving 1/12 or 8.3% of your monthly income.
This will allow you to build your
emergency fund by one month every year. After only six years you will have a
six-month supply of emergency cash. Then you can continue to extend your
"coverage-period" or you can divert the monthly payment into other savings or
Most people find that "billing" themselves
for savings and investments is a good way to put your savings on auto-pilot. If
an amount is taken automatically from your bank account each month, it is easier
to handle than if you wait until the end of the month and try to save from what
you have left over. (How often do you have anything left over?)
So where is the best place to keep your
emergency fund? Probably not a place where you can have easy access to it - too
tempting. Definitely not as cash in the cookie jar - too unsafe (and no
interest). And probably not in 5 year CDs - too restrictive. You may want to
avoid CDs altogether so that you are not charged an early withdrawal penalty
when you can least afford it.
Savings accounts are OK, but usually pay
very little interest. If a savings account is your choice, open one at a bank
that you don't regularly use. Also don't get a checking account to avoid the
temptation to spend "just a little" bit here and there.
Or look for a money market account that
pays a reasonable interest rate. You may want to consider a money market account
that only invests in tax-free securities. This way you won't have to worry about
paying taxes on your interest.
Then set up an auto-withdrawal from your
regular checking account or direct deposit amount from your pay check right into
this new account. Adjust your budget to accommodate having less money each month
and forget about it.
You can also give your emergency fund a
boost now and then by putting "windfall" money into to it. You know
"free-money"; birthday gifts, inheritances, insurance settlements, escrow
overages, rebates, tax refunds, etc.