The first step in any good financial plan is to establish an emergency fund to handle life’s emergencies and break the cycle of turning to debt. However, some people feel a reluctance to use the fund in an emergency and turn to credit cards to cash flow each bump in the road. This phenomenon is driven largely by fear – fear that a bigger emergency will happen before adequate time to rebuild the [tag]emergency fund[/tag]. Here are a few strategies to combat that fear.
Think of your emergency as a personal line of credit. It might even help to sign up for an account that offers a debit card. I keep my emergency fund debit card in my wallet with one of those ATM card slips that says, “Break only in emergency!” When Murphy strikes I use that debit card to tap my emergency fund rather than turning to a credit card.
Hang on to your oldest, no-fee credit card until you have established several months of savings. By keeping one credit card with available credit you still have a backstop should you have the unfortunate luck of getting hit by two emergencies in the same month. Be sure that the emergencies are real emergencies – clearance items at your favorite store do not qualify.
Emergency funds should remain in a highly liquid account. The majority of your emergency funds should be socked away in a high-interest savings vehicle, like a savings account with a top online bank. We also keep a local, smaller emergency fund in an interest-bearing checking account (with debit card access). I could get a higher rate of return on this smaller amount elsewhere, but I have discovered that the higher the rate of return on my money the more pressure I feel not to touch it. This is especially true of holding an emergency fund in stocks or mutual funds. If the market is up, I don’t want to cash out because it might go higher. If the market is down, I don’t want to cash out until it goes back up again. Best to simply keep the emergency fund in easily accessible cash.
Make rebuilding your emergency fund a top priority after each expenditure. If your car died last week and the repair bill topped out at $600 you should quickly find a way to refund that $600 back to your emergency fund. Stop paying extra on your debts until that $600 has been replenished – minimum payments only. Take some extra overtime next week. Round up some old books and DVDs and sell them on EBay. The point is to make rebuilding that emergency fund your number one priority. Having that plan in place before the emergency will make it easier to swallow the $600 hit to your emergency fund, because you know it will be quickly replenished.