All Business & Investing Economics

Emergency Fund

If you were suddenly hit with a $500 unexpected or forgotten bill, would you be able to cover it? Research finds that while we estimate routine purchases well, we underestimate “special occasions.” So, when a wedding anniversary comes up, or we’re presented with an exciting but expensive opportunity, we splurge, thinking of it as a rare occurrence. But these “rare occurrences” aren’t as rare as we think. When we fail to factor all these exceptions into our budgets, we overspend, also making it harder to save.

When used responsibly, credit cards are a valuable financial instrument that allows us to “smooth” consumption. We borrow from the future during lean times (or before we get paid) to maintain a constant standard of living. Still, this assumes that we will make enough next month to pay for this month as well as that month. Otherwise, we can get caught in a cycle of expensive credit.

Moreover, there are the less positive and more chronic events. For example, if you or your partner became jobless – how long could you go until overtaken with stress? Same for injuries, accidents, and other difficult events. At these ‘rainy’ times of your life, money is often the last thing on your mind.

The goal is to increase your wealth and that the emergency fund is the least risky, highest liquidity bucket to help during tough times. Building a reserve that can sustain you for 6 months in low risk assets – such as a high yield savings account is the commonly advised way. Remember that savings should never grow along with expensive debt – so pay off credit card debt first!

Benefits of an Emergency Fund

Emergency funds provide liquidity –access to money – as needed and is the cushion that will help you through any ‘rainy days’ in life. If there ever comes a time when you need some money at short notice, your emergency fund can act as a safety net. Financial security keeps stress at bay and avoid the traps that expensive credit card debt can lead to.

Although the relationship between income and happiness is weak, there is a stronger relationship between happiness and difficulty of paying bills.  In other words, what we owe is a bigger predictor of our happiness what we make. Households with more debt exhibit lower happiness and more marital conflict. Emergency funds can prevent the need for added debt and alleviate stress.

So, what is the problem? Why don’t we save? It’s not, as you might guess, just because many Americans are too poor to set money aside. Certainly, a lack of resources makes it hard (and in some cases, impossible) to save, but research shows that for many of us, the problem lies elsewhere.

Anytime you’re trying to accomplish a goal, always do everything you can to set yourself up for success in advance. We are all different and so some tips may be more impactful than others. Consider this an investment in yourself and do what helps you reach your goals!

Issue: Temptation
Solution: Segregation

If you were trying to lose weight, you wouldn’t put cupcakes and soda at the front of your refrigerator, would you? No, of course you wouldn’t.

One of the biggest mistakes you can make with an emergency fund, or any type of savings account in general, is keeping your money in the same account as all your other money… or even the same bank for that matter.

Saving money is the same. Don’t put your emergency money in an easily accessible account. Make it easy to deposit into but difficult to withdraw from. For example, look for high yield accounts – such as credit unions. Remember that you should be able to take out funds as needed and at a short notice. This means that you should avoid investing it!

Moreover, give your account a specific name that will remind you of what it means to you. For example – My Emergency Fund or My Safety Net. Seeing the name it will serve two purposes: it should make you feel so great to know you are building security, and by reminding yourself of your goal you will be less likely to raid the account for a non-essential expense.

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Issue: Inertia
Solution: Automation

Every minute tons of stimuli vie for our attention. Paying attention to just a portion of everything out there is hard. It’s no wonder that remembering to save money for something is not high up on our to do list. We can combat this inertia – our tendency to inaction – by automation.

Research has shown, for example, that automatically enrolling employees in retirement plans and setting the default contribution rate above zero—typically at 2-6% —increases people’s retirement savings. You can instruct your bank to debit your account with a certain amount periodically and transfer it to your Emergency Fund account. That way, you need not worry about adding the money to the account yourself. Image result for Inertia

Issue: Too Little or Too Much
Solution: Sustainability

Accumulating savings isn’t easy. It would take five years to accumulate 6 months of salary when saving 10% of income. If you have experience saving, then this might be less challenging. Otherwise, remember that everyone starts someplace. Modest amounts are meaningful and encouraging. Hit your starting goals, raise the bar higher and continue challenging yourself. Once it starts growing, you can check back and derive satisfaction from seeing the continuing success of your efforts! Sustainability requires our psychological buy in and that can take time to develop.

It is important to take out money only when you really need it – that is an emergency. So, try not to put in too much money one month only to take it out the next month. Train yourself to put in as much as you can live without. When an emergency does happen, your fund will have served its purpose. However, that does not mean that you do not continue to build it back up when possible.

Spiritual Investment is the foundation of sustainable happiness. We can live a life we want without fearing or hoarding for the future. Saving for emergencies should be balanced with living a fulfilling life and investing for retirement. We each get to decide with what we fill our lives. Happy Money suggests spending that increases happiness and there are other goals that we can focus on. Maintaining mindfulness of our spending and saving ensures sustainability.

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What do you think?

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