Although money isn’t something I’ve worried much about in the past, lately I’ve been focusing a lot on it. The reason for this is simple: I’m finally putting my big kid shoes on and moving out of my parents house – or at least doing it soon. The question is, what kind of state do I want to be in when I leave the nest? Do I want to leave in a state of debt and “I don’t know” or do I want to leave knowing that I have something to fall back on in case disaster strikes?
Before I get into that though, here’s a true story about little Fred Tracy from third grade.
Saving Versus Spending at 8 Years Old
I was 8 years old and we had just been told about a cool little program our teacher was using to get us to learn more and do our homework. The program was pretty simple. Basically, we would get points for good attendance and good grades, among other things. Throughout the year, we would be able to spend those points on various events like movie days and field trips. And at the end of the year, we could spend ALL of our points at a classroom auction the teacher was having.
I’m not quite sure what was going on in my little mind, but I must have been pretty excited. I patiently turned in all my homework, did really well in school, and collected as many points as I possibly could. Many other students did this as well. What set me apart, though, was my ability to sacrifice and postpone gratification. I’m not even sure if this is healthy behavior from an 8-year-old, but here’s what I did.
Like I said, I did really well in school, but remember all those cool movie days and field trips? I actually skipped out on them and hung out with the kids in detention. Not because I thought it was cool or anything, I just wanted to save those points! I can remember very vividly sitting in detention with all the kids who couldn’t afford to pay (in teacher points) to go to the movie our class was seeing. One of the first things the adult who was watching gripingly said was, “Okay, you’re all here because you’re in trouble and didn’t do well enough in your class to earn enough points to see the movie today.” I very quickly let him know that this did not apply to me, and that I was gaming the system.
The moral of the story is this: Even though I had to sacrifice a few movie days and field trips, I got a lot of cool stuff (to an 8 year old) at the end of the year. This is exactly how money works in real life. You save and prepare, and then you profit.
Creating a Fully Funded Emergency Fund
The reason why I’m so excited about saving now is that I just finished (well, almost finished, I wanted to tell you guys about this today) watching a seminar by Dave Ramsey. I have no idea what his reputation is to most people, as I’ve just been exposed to him, but some of the things he has said has already revolutionized my life plan. One of the most important things is the emergency fund.
According to Dave, a fully funded emergency fund consists of about 3-6 months of complete living expenses. That covers food, shelter, utilities, transportation, and so on. It is the stuff that you absolutely can’t live without. This does NOT include big-screen TVs or credit card bills.
Therefore, how much you are going to have in your emergency fund depends on how much you earn and spend now. For me, since I’m still living at home, all I have is one credit card bill (of which I’m paying off completely by next month, more on that later), so I have to project forward a bit and see how much I will need.
To that end, I’m settling on roughly $5000. I have a friend who is essentially in the same situation as me, and she spends about $1000 on bills a month living by herself in our area. Therefore, I’ll have 5 months worth of money in my emergency fund in case disaster strikes.
Why Create an Emergency Fund? Why Not Use Credit?
For most people, their credit card IS their emergency fund. If something bad happens, they just put it on the card and (hopefully) pay it off later. The reason why you shouldn’t do this is simple: credit is stupid. There is almost never a real reason to use credit when you plan your finances consciously and conscientiously. The only excusable situation I can think of is for purchasing a house where you pretty much have to have it and can’t pay all that money up front. Otherwise, stay away from credit. There’s a reason why banks and everyone else want you to sign up for their credit card so badly – statistically, they will make a LOT of money off of you. Even if you pay off the credit card before interest is billed each month, you’re just breaking even. Why not take that money, invest it, and let it gain interest for YOU?
Financial things aside, the real reason to create an emergency fund is peace of mind, and as you well know, that’s what I’m all about. According to some statistics I learned from the seminar, roughly 7/10 people will experience a significant financially draining event in the next 10 years. That’s a pretty small chance to scrape by and be okay not having an emergency fund. Why not be prepared?
This becomes even more important if you have kids and a family. I’ve decided to stay single for, well, ever – or at least until further notice. If you’ve read my articles about relationships then you know why. That being said, if something bad were to happen to me, the only person relying on me, is me! I don’t have a situation where if I become unable to work, my family is going to starve. And yet even I am setting up an emergency fund. If I’m doing that, how much more important is it for someone that is the breadwinner of the family to do it?
How to Use an Emergency Fund
There is only one situation in which you should use your emergency fund. For emergencies! There is no other situation under the sun to use this fund. Ideally, you want it sitting there doing nothing. Don’t use it to invest, don’t use it to pay off debt, and don’t use it to pay cash for that really good deal you just saw. Just leave it be. That’s what it’s supposed to do.
How’s that for simple? I think a lot of people know they should have some money in savings, but it’s not enough at the forefront of their consciousness to actually do it. This is your reminder. Right now, devise a plan to top off your emergency fund (3 to 6 months of living expenses) ASAP. You can’t afford not to.
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