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Do you have an emergency plan in place?

Written on August 10, 2008 at 10:46 am, by rhonda

In the last few issues of ‘itsHERmoney’ we discussed the importance of organizing the 5 rooms of one’s financial house; our personal debt room, our savings plan room, our retirement plan room, our estate plan room and our insurance needs room. Last month we tackled the topic of managing and understanding our ‘debt room’. In this issue we will deal with our ‘savings plans room’ or more specifically the importance of establishing an emergency savings fund.

Why are emergency savings so important?
As they say, “life happens when you’re busy making other plan” and life tends to cost money. Having enough money put aside for such unexpected events can be the difference between staying afloat or sinking financially. So one of the most important elements of your financial plan is to ensure an emergency fund is in place – and sooner rather than later.

Why an emergency fund?
An emergency fund is an easy to access pool of money to be used solely for the purpose of emergencies. Having an emergency fund in place gives you the “peace of mind” that you can handle most financial crises that come your way. This could be anything from an unexpected car repair bill to losing your job. Unfortunately, those who have not planned in advance for such unexpected events tend to borrow the money at the last minute and often at very high interest rates. In addition, those without emergency funds tend to collect more debt overtime.

So how much is enough?
This depends on many factors specific to each person’s situation such as, how employable you are, whether or not you carry substantial debt, if you have adequate insurance, if you are a dual income household and/or if you have children. The general rule of thumb is to have 3 to 6 months of your current living expenses set aside for emergency situations. However I recommend the following to my clients:

• At the very minimum save a $1000 now in a separate high interest savings account. Set it up so it cannot be accessed by your ABM card. This will help protect against impulse buying. Remember an emergency isn’t, “I NEED those shoes’ but truly an unexpected bill or expense.
• When you have that $1000 saved and put aside you should aggressively start paying down those high rate loans and/or consolidate your loans into one lower rate manageable loan.
• Finally, when your debt is paid (excluding your mortgage) it is time to start saving 3 to 6 months worth of your current living expenses. If you find that you are spending what you earn then take 3 to 6 months of your current after tax income as the barometer of how much you need to put aside.
• I also recommend setting up a line of credit that would cover a few months of emergency expenses. I say this with caution to those who have trouble steering clear of debt. This is solely to be used for emergency means only.

How to get started on your emergency savings plan

• Determine what you can ‘reasonably’ afford to put aside each month – $25, $50 or $100
• Setup up an interest bearing savings account to save the initial $1,000. Again I advise that you open up an account that is not easy to access i.e. no chequing or ABM privileges. This $1,000 will help cushion any unexpected bills that may come your way.
• Set up an automatic process to save – this can be an automatic monthly payment or an automatic transfer between accounts.
• When you are ready to start saving the larger emergency reserve- 3 to 6 months worth of your current living costs – open up another high earning savings account or a money market mutual fund (the latter is not as easy to access and takes a few days for the monies to settle once sold. It also tends to pay a bit more interest than a regular savings account). You want to ensure these funds are liquid and assessable when needed but are also growing with the cost of living (after tax and inflation.
• Make sure that you keep your emergency funds separate from any accounts that you are using for other savings purposes, like reno’s, travel or a new car.

How to find money to save

• Basically, spend less than you earn
• Save all your loose change
• Have a garage sale.
• Review your current expenses/bills to see where you can make some sensible changes – do you really need the movie channel?
• Cut back on indulgences (Bring lunch to work, have one less cappuccino a week, eat out less, and/or rent a movie versus going to the theater).
• Consolidate your debt into one low interest loan.
• Pay cash for all your purchases. People tend to curb their impulse buying when they actually have to fork over cash to make a purchase. Using cash also helps prevent out of control credit card debt and saves on the interest charges you incur when you borrow money.
• Cut down on bank machine withdrawals – those service charges do add up.
• Find creative ways to make extra money. Do you have a skill set that can be put to work?

Financial emergencies can come at any time and at any cost. All you can really do to help protect you and your family from such financial crisis’s is to ensure you are adequately insured and that you have enough savings put aside to help ride out whatever uncertainty comes your way. Start small if need be but start soon.

Rhonda Sherwood, CFP, FMA
Wealth Advisor
http://www.rhondasherwood.com
http://www.itsHERmoney.com