Murphy has your number. As soon as you put money away, thinking things are going well, Murphy comes knocking on your door to take it away, leaving you with a debt you may not be able to recover from. In order to counteract Murphy’s machinations, you need to consider creating and maintaining an Emergency Fund. What it is and how it can be used is described below.
The Murphy Shield
An Emergency Fund is what it sounds like – an account used in the case of unforeseen circumstances. For instance, money may be released from the fund if a major repair is needed on your residence or car. If you’re laid off from your job, the Emergency Fund is used to handle routine expenses not covered by unemployment, including higher medical bill rates due to the loss of health insurance. The Emergency Fund is also utilized when a accident causes or a member of your family to be on short or long term disability.
What Should It Contain
On average, your Emergency Fund should cover between three and six months of household expenses — not three to six months of gross or net pay. Household expenses include mortgage or rent, fuel, food, groceries, utilities, transportation costs, needed clothing, and medical expenses not paid by health insurance programs. What shouldn’t be included in your Emergency Fund are monies for vacations, dining out, or other recreational activities or hobbies. The account is only used to temporarily offset costs in the event of an emergency and should include just the basic expenses.
Determining the Value of the Emergency Fund
If your family works off a weekly or monthly budget, you should have a good idea of the average expenses for a three to six month period of time. If not, some research needs to be conducted. Start by saving receipts and bills for all of your daily and weekly expenses. At the end of the month, sit down and calculate the average amounts spent for food, fuel, utilities, etc. Multiply this by three or six, add in an extra five or ten percent for increases in the always-fluctuating food and fuel prices, and you’ll come up with the amount you need to populate your Emergency Fund. Even better, pick a budgeting software package like Quicken, add in all your receipts, and let it help you determine what you’ll need for the fund.
What Not to Do
First and foremost, don’t think your Emergency Fund is there to spend on vacation or the new vehicle you’ve been eying on your way to work. Taking money out of this fund for non-critical expenses is a sure way to lure Murphy toward your residence. It’s better to start separate accounts for these luxuries to keep the monies separate.
Second, avoid placing some or all of the Emergency Fund into volatile investments or accounts packed with hefty fees for early withdrawal. For example, you risk losing a good portion of the fund if the stocks you invest in take a sudden downturn. Or, you could be out part of your monies thanks to withdrawal fees and federal taxes if it’s invested in an IRA or your 401(k). Consider a short-term CD with the ability to make no-fee withdrawals if you absolutely feel the urge to invest your Emergency Fund.