Now that I’m finally back in the swing of things here at Debit versus Credit I’m ready to bring back a popular feature (and one which I enjoyed very much): Friday Book Club. I began Friday Book Club in November of 2007 with three goals. First, to be able to share what I’m learning with all of you. Secondly, to absorb the material that I’m reading more efficiently by reviewing it and summing it up in a matter of just a few paragraphs. Then finally, to be able to apply what we’re learning to our personal financial lives and share with each other experiences that relate to the lessons and topics at hand. These are my goals and I hope that you will share these common interests with me. Now then, where were we?
Today’s Friday Book Club will feature chapter 5 of The Automatic Millionaire which was written by David Bach, the New York Times Bestselling Author of Smart Couples Finish Rich and Smart Women Finish Rich. Chapter 5 is entitled Automate for a Rainy Day and is all about creating an emergency fund, or a rainy day fund, for protection. I’m a big believer in this. In fact, my wife and I are already well on our way to having a six-month emergency fund saved up. We’re about halfway there right now and it has been one of the easiest things that we’ve ever done. You see when we got married we decided that we didn’t want to be like some of our friends who got into financial troubles (even little ones sometimes) and didn’t have any way to cover these “emergencies.” So we decided that before we did anything else with our money that we’d establish an automatic savings plan which would begin an emergency fund for us. It’s paid off quite well for us and we have peace of mind now if anything bad were to happen. On to David’s advice then…
The “Sleep Well at Night Factor”
“How can you provide yourself with some financial security today?” is the question that David asks within the first few paragraphs of this chapter. Are you prepared if something were to happen? Could you pay your bills if you lost your job and were unemployed for two months? Things happen and as he says, “circumstances change.” So what can you do to provide yourself with some insurance against this chance of risk? Of course the answer is quite simple. By setting aside cash as an emergency fund you can help protect yourself and your family from any financially devastating changes. How well are you prepared to weather any storms that life might throw at you? David asks just a few simple questions where you can easily figure out the answer to this question. I’ll ask them as well.
- My monthly expenses currently total: $_______________
- I currently have $_______________ saved in a money market or checking account
- This equals _______ months’ worth of expenses
How’d you come out? I’ll do it with you. My monthly expenses currently total (roughly) $1,162 dollars. This includes some items which I could drop if needed (such as the internet and my phone). I currently have $3,299 dollars saved in an emergency money market. This equals 2.84 months worth of expenses. Not the six months that my wife and I are shooting for, but like I said it’s a good start.
Let’s Make A Goal: Build An Emergency Fund
Let’s decide together – right now – to not let ourselves get caught in a bad situation made worse by not having any cash on hand to weather catastrophes. It might sound like a difficult thing to do, but as long as you make it automatic every single month you’ll never even notice the money is missing. It will not happen overnight but over time you’ll notice that you have a month, two months… four months and finally six months worth of expenses saved up. So back to the book then. At this point David lays out three rules of emergency money.
- Decide how big a cushion you need.
- Don’t touch it.
- Put it in the right place.
Decide The Cushion Amount
When it comes to deciding an amount you’d like to have as a cushion it’s mostly a personal choice based on your personal situation. Finance is not and should never be thought of as a one size fits all type of thing. Since we call it personal finance, we ought to make sure it’s personal right? Anyway back on track now. I recommend personally at least a six month cushion, just to prepare for the worst. Maybe it’s my old boy scout genes talking, I don’t know… but I think one ought to be prepared. Of course if you’d feel comfortable saving more then please do. Or on the other hand if you think three months is more than enough than fine… it’s all a matter of preference.
Don’t Touch It
Here’s where most people start to have trouble with these emergency funds: they use them for non-emergencies. There’s a sale at the shoe store and you don’t have any cash? Don’t take it out of your emergency fund. Saw the latest and greatest gadget while browsing the lanes at Best Buy? Don’t take it out of your emergency fund. Lose your job and don’t find a new one for a month or two? In this situation, you might consider using your emergency fund.
Put It In The Right Place
As David mentions in his book you should not be letting banks get rich off of your savings. Don’t put your emergency fund in a savings account at your bank or credit union if you’ll only be getting .50% percent or even 2% interest on the balance. Shop around. See what rates you can find on savings and money market accounts at your bank, your credit union and even brokerages. There are a billion places that are offering rates much more suited to your needs. Give Vanguard a try, or ING or Edward Jones. Look at Bankrate.com to see what rates are being offered in your hometown. The point here is that if you’re going to have money you might as well have it work for you. If you plop your money in the first 1% savings account you find it’ll take your money 72 years to double, but if you can find yourself a rate at something even like 2.5% you’ll cut that amount of time down to 28.8 years – and even less the higher the rate you can find.
That’s All For Now
Chapter 5 wasn’t very long and wasn’t even very meaty – but it’s a ridiculously important concept that is far too often looked over by consumers and financial advisers alike. To recap:
- Bad things happen and to be prepared for these bad things you should start an emergency fund
- Decide how much of a cushion you think you need
- Don’t touch – unless it’s a TRUE emergency
- Make sure you don’t just plop your emergency funds in a low-interest savings account
- Make it Automatic: set your paycheck up to direct deposit a predetermined amount into your emergency fund every month
If you’re interested in checking out my previous recaps of The Automatic Millionaire then check out the links below. I highly recommend doing so.