Friday, March 20, 2009

How I Sabotaged My Emergency Fund: 5 Mistakes & Cures

Common wisdom tells us to have an Emergency Fund with at least three to six months of living expenses. I'm on my way to that savings target, but my efforts have been hit by setbacks. Here's where I have made mistakes, and here's how I plan to fix those errors:

1) Easy Access: For the sake of electronic ease, the account containing the Emergency Fund was linked to my primary checking account. Bad move! For sure, that link made it easier to transfer money into the Emergency Fund. But that same e-link made it easier to transfer money out of the Emergency Fund.

Solution: The April 2009 issue of Money Magazine offers this advice: "Your emergency fund -- cash you'll need if you lose a job -- must be in a bank account that's 100 percent safe but needn't be so convenient; if you get a good yield, don't worry if it takes a day or two to transfer the money."

2) Multi-tasking funds: I've erred by establishing a one-size-fits all savings account. It's too easy to use emergency funds for other savings goals or spending binges.

Solution: Vacation account savings, funds for long-term purchases and emergency money should not be housed together. General household funds also need their own home. "Grocery money goes in checking," according to a great piece featured in Money called: "5 Things to Know About Stashing Your Cash," by Sarah Max. See also: The 7 new rules of financial security

3) Unreasonable goals: Unrealistic targets are formulas for failures. When I set the savings bar too high, I feel defeated and slide back into bad savings habits.

Solution: I'm downsizing my dreams and targets. I'll save more if I demand less.

4) Lack of Priorities: When I pay myself last, I often fail to pay myself at all.

Solution: The Emergency Fund should rank above other savings goals, including vacation accounts, holiday gift funds and other savings targets.

5) Emotional loopholes: As a creative writer, I can be very creative with my rationalizations about saving, spending and living. A wide list of so-called emergencies can rain on the Emergency Fund umbrella.

Solution: Effective April 1, I will track my expenses for a two-month period. This daily accounting should provide an honest picture of where my money is going. Also, I will create and adhere to strict definitions about the emergency cash. It might help to have a lowercase emergency fund for household expenses and an uppercase Emergency Fund with cash sufficient for three to six months of living expenses.


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zach said...

I have this problem as well. I contribute $416.66 to my Roth IRA every month, and it gets automatically withdrawn from my emergency fund. A few months ago, I had over 4300 dollars in my emergency fund and had built it up pretty quickly. Well, times are a little tougher, and the contributions were still being made but I wasn't supplementing my emergency fund at all.

Now, I'm down to $3500.

I now realize that I have to separate the accounts so as to not make the emergency fund dedicated to anything but.. well.... emergency funds. ING makes it easy enough to create other accounts for things like Roth contributions or savings goals. And would recommend the same to anyone trying to save up money. Automate everything and make your emergency fund accessible, but not easily available, and only allow money to go in, not out.

banking deals said...

I always had personal-finance conversations all the time? I don't often initiate them, but money seems to be a constant topic, even when people are unaware that I write about it every day.

Shayna B. said...

You hit the nail right on the head with this post. It's so easy to just skip out on the most important thing - adding to your savings/cutting down on debt.

My biggest flaw is the emotional loopholes point. Dang those emotions. If I have a bad day, I let myself go over budget and spend $5 on a coffee. As a result of being lax in this area, I let myself spend more elsewhere. Bad news bears.

I think I'll track my spending, too - two months too ambitious for me, though. I'm thinking one week :P

Hope to hear your results!