Cash to the Rescue: Our Need for an Emergency Fund

An emergency fund, otherwise known as the "Destroyer of the Oh Crap! Response to Unexpected Expenses," is an essential part of your total get-out-of-debt strategic plan.

Consider this scenario that happens somewhere every day: Your car isn’t running like it should, so you take it to your local repair shop. Your mechanic finds that fuel additives have clogged and ruined a small part, about the size of a credit card, which will need to be replaced. "Whew," you say. You think to yourself, "Tiny little part, can’t cost much." Oh, how wrong you are when you hear the $700 price tag for the part and labor. Oh, crap!

Without an emergency fund, where do you turn? You seek out your credit card, which, incidentally, is the same size as the tiny, expensive car part. That takes care of it, car fixed. But, you’re further in debt. You have no immediate way of paying for the $700 repairs, or you wouldn’t have charged it in the first place, so the $700 repair will end up costing you much more in finance charges on your credit card.

If you had an emergency fund, your $700 repair would only cost you, you guessed it, $700.

There are other ripple effects of using your credit cards for unexpected necessities. For example, when money is tight and you’re trying to emerge from the debt dungeon, adding to your credit card balance increases your monthly payment and slows your debt reduction plan. That, in turn, kills your confidence and will to keep going. Never underestimate the psychological impact of credit spending.

If you don’t have an emergency fund in place, now is the time to start "funding the fund." If you’re at the beginning of your debt reduction plan, or in the midst of it, personal finance expert, Dave Ramsey, recommends that you set aside $1,000 in an emergency fund (see his book Total Money Makeover). If you’re a student, or your normal expenses are minimal, $500 may suffice.

No, you don’t need to fund it all at once. Simply pay yourself $25, $50, $100 per month, or whatever amount you can afford, and keep adding until you get to $1,000.

Oh, another thing. You shouldn’t keep your emergency fund where it’s easily accessible, as in a normal checking account. Find a good money market account, that pays you interest. Sure, you can still write checks from the account, but many have limits set on the minimum you can withdraw. For example, I have a money market account that prohibits me from writing checks for less than $250. Keeps me from spending money on small, non-emergency purchases. According to the blog, Get Rich Slowly, you should "consider opening a savings account at an online bank like ING or Emigrant. When an emergency arises, you can easily transfer the money to your regular checking account."

When you get out of debt, you can then start your gonzo emergency fund of six months or so of living expenses.

It may seem counterintuitive to start saving money before you’re out of debt. But, if you don’t pay yourself at the outset, or wherever you are in the process, you won’t be able to cope with the unexpected. Then, the evil creditor will be waiting with open arms.