Posts Tagged ‘Finance Management’

The Emergency Fund: Your Financial Red Cross

What do you do when:

  • your source of income suddenly stops?
  • you’re suddenly ill and insurance can’t cover all the costs?
  • you have to travel immediately due to a close relative’s passing away?
  • your car breaks down and you realize you have to spend $700 or more on repairs?

Sure you can use credit cards to cover some of these expenses, but how long can you do that for especially if the first situation is also true. This is when the Emergency Reserve comes into play. It sounds basic and like common sense, but this is the most important account for any independent person (and often the most overlooked). In discussing this, we can focus on the What, Why, Who, Where, When and How?

Emerg_Fig1

What: What is an Emergency Reserve?

According to the Merriam-Webster Dictionary Online, an emergency is

An unforeseen combination of circumstances or the resulting state that calls for immediate action

Two words stick out clearly here: unforeseen and immediate. Consequently,

An emergency reserve is money kept aside for unforeseen situations that call for immediate attention and action

This means that this money should only be used for things that are unplanned. Consequently, emergency reserve should be separate from your savings. Usually when we save, we are saving for a goal e.g. a vacation, new gadget, textbooks, accessories etc. As such, while savings is usually money for planned activities, an emergency reserve is money for unplanned activities. In a way, you can call your Emergency Reserve your financial Red Cross because it arrives on the scene when emergency rears its head.

Why: Why should I care about an Emergency Reserve?

As mentioned above, this money is for unforeseen circumstances which can (and does) happen to anyone. Thus the prime reason for having this reserve is simply: peace of mind. Rather than worry about money in a time of crisis, you know there is money somewhere and that helps to focus on the crisis itself. Besides, if you already insure your car and health, shouldn’t you also be insuring your finances as most emergencies hit the pockets first?

Who: Who should have an Emergency Reserve?

An emergency reserve is necessary for anyone who is (or wants to be) dependent on themselves for financial resources. Therefore, this person has some sort of regular income which pays their bills and they are not necessarily dependent on their parents or family members. This reserve is also important for those who have dependents.

When: When should I start an Emergency Reserve?

As soon as possible! Right after reading this article!! I’m kidding. Well kinda. In all seriousness, you never know when you will need this, so it’s best to start as soon as you can.

Where: Where should I keep my Emergency Reserve?

Since this money is required for immediate action, it should be kept in a savings account that is linked to a checking account. This way, the money can be easily transferred when it is needed. I would stress here that it shouldn’t be in a checking account simply because just as much as this money should be accessible, it should also be untouched. With an emergency fund tied into a checking account this is very prone to happen.  In addition, the advantage is that it generates interest while sitting in the savings account when untouched.

How: How much should an emergency fund have?

For this question there isn’t always a straightforward answer. I have heard of 1 month, 3 months or even 6 months worth of expenses saved. I have also heard of using figures like $1,000 – $5,000. I personally keep set my goal at $1,000 just because it’s a nice round figure and also because it covers a month worth of expenses at the moment. When I leave graduate school and start a family, I am sure that number will go up. The most important factor here is that you set a minimum that will give you peace of mind.

I’m hoping that I have somehow convinced you about the relevance of this very important financial tool or at least initiated some thoughts into starting your own emergency reserve. When crisis happens, you will have your own Red Cross to lean on.

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Where is my money going?

Those who cannot remember the past are condemned to repeat it – George Santayana

When I began this blog, one of the things I wanted to discuss was managing money i.e. budgets, investments, frugality etc. This will be one of my first articles towards that end with more to come in the future.

When I first got out of college, I took a year off to try to find work before I returned to graduate school. At this point, I was in credit card debt. The first credit card I ever got extended me $5,000! First of all, I had no business being handed a credit card equal to that amount as I was earning about $6,000 annually (from tutoring and working in the dorms). However, I was the one who mismanaged credit and handled the card as free money. When I was broke, I would pay for things using the card and buy stuff that I could honestly have done without. I got drunk with purchasing power and over time, I got other cards and bought more stuff. Therefore it was inevitable that when I got out of college with no income, I would end up being very broke. I knew I had to fix my leaking boat before it sank and I drowned with it. This was the point where I began to figure out what personal finance was and how to be the navigator of my financial journey.

The first thing I had to learn was: Where was my money going? This is usually the first step that most personal finance managers will tell you to do. Even though I had an idea that I was spending a lot on clothes and food and electronics, I needed to know what percentage was being spent where. This would help me figure out where money was being spent (or wasted) and the first things I would probably need to trim when I wanted to manage my finances properly.

I started with Microsoft Money that a relative had purchased, but it wasn’t free and I believe at this time Microsoft has actually stopped selling this program. In more recent time, numerous free online tools can be used for this same purpose. There are three that I have experience with Mint, MoneyStrands and Thrive

My favorite so far has been Mint for functionality and interface, but I’ll leave you to check out some reviews to decide for yourself (Mint Review, MoneyStrands Review, Thrive Review)

So what do these sites do? First, they consolidate most your financial information into one site i.e. checking accounts, savings accounts, CDs, credit card accounts and investments accounts as well. Secondly, they each have a feature that is able to show you graphically where all your money is going i.e. groceries, rent, food etc. You can basically pull up a pie chart in Mint that will show you proportions of where your money went for a certain month. This works very well if like me you have multiple accounts because it allows you to keep track of  how much was spent on gas overall whether it’s on a credit card or a debit card. Here’s a screen shot of my spending in August 2008 just to give you an idea of how this feature works (As you can tell I wasn’t very smart with eating out)

One of the worries that people have is about the security of having to enter bank information into a third-party site. I will tell you that I have been using Mint since May 2008 and I haven’t had any issues. If however you’re still worried, then there are other options such as Microsoft Excel and paper and calculator. In the end, your peace of mind is the most important factor to consider.
Overall, this is where you can figure out how much you’re spending on fast food per month, or how much gas you spent last month in comparison to the two previous months or how much you spent at Christmas last year and so on. This first step will help in setting up a clearer view of your financial picture as the next step is preparation of a budget.