Emergency or Disaster?
November 18, 2011I don’t know how much the rest of the country paid attention to a very early snowstorm in the Northeast, but I had to pay attention to it. It was a big part of the last week or so of my life. I travel to Connecticut a lot and nearly the entire state was without power for a few days. Those days happened to coincide with the dates that I was supposed to be there. Have you ever tried to call a hotel that doesn’t have power to confirm your reservation? I hadn’t until this storm hit. And, since I couldn’t reach them I kept my travel plans because I didn’t want to be a “no show” for the meetings that I was supposed to attend. And, when I got within about an hour of my hotel, I got an email that my reservation was cancelled. Perfect! Here I am, far from home, close to where I’m supposed to be for work, and nothing in the area has electricity. Fortunately, I have a phone full of contacts and I scrolled through my list to see who I could call as my Plan B. Eventually, I found a place to sleep that had electricity, which means HOT water for the shower!
What’s the point of this story? It’s to point out that “Stuff Happens.” And, many of life’s unexpected happenings cost a bunch of money. For me, it was late notice hotel changes disrupting my travel plans. A few months ago it was a water pump for my car. Last summer it was the water system on my boat. (What is it with me and water?) All of this “stuff” required some out of pocket expenses. Fortunately, I have an emergency fund to cover things like this and it isn’t a major disruption.
I met someone last week who doesn’t have an emergency fund. A financial rule of thumb is to build 3-6 months of expenses as an emergency fund, although in this economic climate 6-12 may be more appropriate. If you’re just starting out, try to get an emergency fund of $1,000 – $2,000 in place quickly. That amount should cover most of life’s mini-crisis situations.
Her car needed about $1,200 in repairs recently. That $1,200 went on 2 credit cards and she is making the minimum payments on those cards. We looked at her statement and after about 10 years of minimum payments she will have paid around $6,000 for a $1,200 repair. That’s not an emergency, that’s an absolute disaster! Why? She didn’t have an emergency fund set aside to cover this. We looked at her budget and found a way for her to reduce her monthly spending by ~$100. That $100 will be used to pay off her credit cards in less than a year, and she is going to set up a $20/pay deposit into a savings account. She will bump that up to $50/pay when the credit cards are paid off. Around 2 years from now, she’ll have no credit card debt and $2,000 in savings to cover emergencies (she’s going to sell some of her kids’ clothing and toys on eBay to jump start the emergency fund). And, from there she will get started on her longer term goals.
When your “basic emergency fund” amount ($1,000 – $2,000) is in place, you have some margin for error. If a car repair or home repair needs to be made, you’ll have the cash to do it. It won’t need to go on a credit card and linger forever and cost multiple times the price of the original repair. In my opinion, the emergency fund is the most overlooked and yet the most important part of taking control of your financial life and making progress toward your longer term goals. If you are struggling to make financial progress, the best thing you can do is to get your basic emergency fund in place. Not only can it provide funds for an emergency, it can prevent a much bigger problem down the road with ever-mounting credit card balances.