Establishing Emergency Savings

Financial professionals tell their clients that they need to have an emergency savings account. This statement raises two questions that need to be answered.

The first question is, "What is meant by the term 'emergency'?" For some, an emergency is paying the semi-annual car insurance premium; for others it is a visit to the dentist's office; for others an emergency is the Visa bill from the family vacation; for others it is a car repair bill . I tell my clients that none of these is truly an emergency. All these expenses are predictable . In other words, you know they are going to happen- sometime. These predictable expenses need to be paid out of the regular budget from accumulated savings-for expenses that are simply a part of your life.

You will want to set up an accumulated savings account to pay for predictable expenses.

An emergency is something totally unexpected. If you have a car, you know that you will have to pay car insurance and car repair bills. So these expenses are not emergencies. If you have teeth, you know you'll be going to the dentist. And you know you take a family trip each year and charge much of it to Visa. None of these are emergencies. So, in order to answer the first question, you'll want to re-define the term "emergency."

Emergency means that it is outside any predictability. Emergency usually is part of some loss or catastrophe-an accident, an illness, a job loss. The purpose of an emergency fund is to hold your life intact-during and after a crisis.

Knowing that everyone needs emergency money for financial protection, how do you decide how much to keep in that account? You don't want too little money or you won't be protected. You don't want too much money sitting in a liquid account either. Liquid money doesn't earn the rate of return that longer term, less liquid money has the potential to earn. In other words, liquid money does not earn enough to keep up with inflation and taxes.

So what is your goal for emergency savings?   Your goal starts with the amount you need to cover 3 months of expenses-three months of your budget. You will probably want to set a goal of higher than three months of expenses if you do not have disability insurance. It needs to be higher if you only have one income in your household. Or if you have two incomes that are earned at the same company.   Or if you are self-employed. Or..anything else that makes your income vulnerable. One or more of these situations is reason enough to increase the goal of emergency savings from three months of expenses to six months.

Once you have established an emergency savings goal, decide how much you will save from each paycheck or each month.    Make sure that money gets deposited.   And leave it there.   Don't let your emergency savings become a revolving door – money in – money out-to pay for life's expenses.   Protect this savings account so you can truly feel safe.