The First Step to Building Wealth: Setup an Emergency Fund

October 21, 2013

Whether you are in debt or have millions of dollars, everyone needs an emergency fund.

If you are in debt and want to get out of debt, you still need an emergency fund. Some of you may ask “Why should we have an emergency fund when we should use every dollar to pay down debt?” The reason why you should still have an emergency fund is because you want to change the habit of relying on debt to finance expenses that are a result of unexpected events.

No one is immune from the unexpected. There is a tendency to think that certain events will not happen to us, because the chances are small. But you know, $#^% happens!

Have you ever gone to the emergency room and worried how much it is going to cost you? Having an emergency fund will help prevent you from using credit cards and paying ridiculous amounts of interest when the unexpected happens. As Benjamin Franklin would say “An ounce of prevention is worth one pound of cure.”

If you are in debt, you don’t need a fully funded emergency fund, just one enough to provide a cushion so you don’t further increase your debts. Depending on your situation, $1000 should be enough while you pay down your debts. As necessary adjust this amount as low as $500 if you have a small income or adjust this amount higher if certain events such as an upcoming job transition or medical procedure justifies a higher cushion.

If you do not have debt, a good rule of thumb is setting aside three to six months of living expenses. If you have a job that is highly sensitive to the economy, I would recommend that you have six to twelve months of living expenses.

The last important thing to note about the emergency fund is to make sure to keep this money some place safe and liquid. The goal is not to maximize interest or beat inflation. The goal of an emergency fund is to have it available when you really need it. The return of your principal is more important than the return on your principal.

How much do you have in your emergency fund?

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