An emergency fund is one of the most important pieces to get in place when you're figuring out your financial puzzle.
For many people, our economic realities make putting money aside to sit-and-wait for a just-in-case scenario can feel maddening -- or seem plain mad. Yet emergency funds are arguably the most important element of a financial safety net. Perhaps second only to “spend less money than you make,” the financial advice to “build an emergency fund” is among the best you can follow.
What exactly is an emergency fund? It is cash set aside to be used only in an unexpected one-time situation and only to prevent imminent danger to one’s physical health. In other words, an emergency fund is money you keep to bail yourself out when a true emergency arises.
Sadly, emergencies will happen; they’re a common part of life. Knowing what is and isn’t an emergency will give you the guidelines you need to manage your just-in-case cash fund. An emergency is a one-time unexpected situation that threatens your access to basic food, shelter, clothing, and/or medical care. Specific threats to each category include the following:
Food – not having enough basic food to survive, having no money for food due to an unexpected situation, already using the food bank and still not making it.
Shelter – receiving an eviction notice, having essential utilities cut off (water, electricity, heat in cold months).
Clothing – lack of basic appropriate clothing to keep you safe and warm to due an unexpected situation.
Medical care – injury or illness that requires medical attention
What do each of these situations have in common? They threaten your very existence.
I want to dwell on medical care for one moment because your well being – financial and otherwise – is tied to your access to health care. You need health insurance; consider this absolutely non-negotiable. Making a choice not to pursue medical care is a decision that threatens your physical health in the short- and long-terms. Becoming sick is never expected, but it is a reality each of us faces even if we seem otherwise healthy. Even with insurance, co-pays, deductibles, and out-of-pocket expenses often lead people to not access these essential services. Having money on hand to cover those costs is crucial. When you have insurance, make sure you are familiar with its terms, copays, and out-of-pocket maximums. Once you know what you may have to pay in the worst-case scenario, add the amount to your emergency fund target goal.
How much money do you need in an emergency fund, and how do you put any money away on your current salary?
Conventional financial advice suggests individuals save enough to cover three to six months of expenses, plus your worst-case out-of-pocket medical costs. We would love to say there’s an easy way for the a person paid minimum wage to reach this goal in a timely manner, but the reality is that saving that much cash for a minimum wage worker takes a very long time. So instead of looking at a large and daunting number, start small. Aim to create a $500 cash emergency fund.
Why $500? This amount will cover small, unexpected events like an emergency doctor visit, a basic car repair, a trip to the emergency vet with a pet, or being short on rent or food. It’s a number within reach of nearly everyone’s budget with some planning, and it’s a good start. If you put $20 away a month, you can have $500 in about two years. Increase your monthly savings to $42 to complete this goal within one year.
When you decide to create your emergency fund, it helps to keep the money separate from your usual living expenses. Keep it in a separate account, ideally a high-interest rate savings account often offered by credit unions and online banks, or set it aside as cash in an envelope or somewhere you will not be tempted to use it.
To build up your fund, consider utilizing these suggestions:
When you’re saving, keep in mind that it’s okay to let this money sit as cash or in a savings account. It may be tempting at some point to invest it to grow your money, but the point of an emergency fund is for it to be there right away when you need it. It’s your safety net. Leave it alone. You don't need it to do anything fancier than sit and wait for you to need it.
Moreover, a credit card is not an emergency fund. If you can’t afford to pay for an emergency need the moment it’s before you, how are you going to afford it later with compound interest added on? A $300 emergency on a credit card may end up taking 18 months to pay off and cost $42 extra in interest. Using a credit card to cover emergencies puts individuals in a bad situation where, on top of the stress of the emergency itself, they’re now in debt. Any further complications or a second emergency situation could damage their financial stability for years.
Consider buying term disability insurance. Employers are required to carry workers compensation insurance, which covers you in case you are injured on the job. Many large companies also give, or offer, disability insurance, which covers you in case you are sick or are injured from something other than a workplace injury. Many bookstores are too small or can’t afford to give employees disability insurance, so purchase a term disability policy in case your health suffers and you are unable to work.
Wherever you decide to begin, getting an emergency fund together is one of the best forms of protection you can give yourself. You’re the only one who’s going to look after you, so be the guardian you would want on your side and be kind to yourself. Make a plan, stick to it, and keep going.
You can do this!
If you have any questions, feel free to email Justus Joseph at Squirrel and Nest.
Today we discuss how to build good credit, but first we'll quickly talk about what a credit score is and why it matters.
Credit scores are an assessment of how responsible you are with money that has been loaned to you. These scores assess your credit history and how well you handled borrowed money.
Why It Matters
Lenders use credit scores to determine how much it costs you to borrow (interest rates), how much you can borrow (credit limits), and what kinds of credit you can have (high-quality loans vs. “revolving credit” [credit cards]).
People with higher credit scores have access to better services and lower interest rates as they are perceived as less of a risk.
People with lower credit scores end up with poorer services and higher interest rates. This means it is harder for these people to borrow, and when they do borrow, carrying a balance costs them much more money due to the high interest rates.
Categories Used to Determine Your Credit Score Include
In order to score well in this category, you need to stay below 30% of total limit available to you. If you utilize more than 70% of your credit and do not pay it off, you will lose points on your credit score. Here are the potential scores based on your credit usage. To have an Excellent score, you need to utilize less that 20% of your available credit:
Not Bad 41-60%
Pay on time. Nonnegotiable. Never be late for a payment. Your most recent payment history counts more than your past history. Here are the potential scores based on how often you pay on time:
Not Bad 98%
Length of Credit
This is measured by the longest standing account you have open -- if you close that account, you won't have as long a history.
Poor 0-3 years
Not Bad 3-6 years
Good 6-9 years
Excellent 9+ years
Multiple lines of credit in different types help raise your credit. Potential lines may include a line of credit, credit card, home loan, student loan, etc. That said, too many can hurt your credit score. (Getting to Excellent on this one isn't actually a goal we'd recommend). Here are the credit scores associated with number of accounts:
Not Bad 6-12
Anytime you apply for credit or have your credit score checked, it is indicated as an "Inquiry" on your credit report. Too many inquiries will negatively affect your credit, as it suggests you are trying to borrow a lot of money within a short time frame. Inquiries stay on your report for two years. Here are the credit scores associated with credit inquiries:
Not Bad 5-10
When dealing with your lenders or collectors, being rude can lower your credit score -- no joke! Be polite when you speak with your lenders, no matter how frustrated you might be feeling. Here are the credit scores associated with instances of derogatory remarks:
Not Bad 2
It's also important to know there's more than company that offers and evaluates your credit score, Equifax often being the best known. Each company will weight your credit score differently, but they generally stay within a similar range of about 300-850.
Bad 550 and lower
There you have it. Credit demystified. Keeping good credit habits will not only help credit score, it's going to help your overall financial situation and may keep you out of significant debt.
Most people living in North America have some form of debt. That can include anything from credit cards, student loans, a car loan, a mortgage, or a payday loan. Given how common debt is, you would think people would talk about it more. But topics such as how much we owe, what interest rate we pay, and what are our repayment strategies are taboo.
Why is the subject of debt off-topic when the majority of us have it? That is one area of
finance people find especially challenging to face, let alone to discuss in detail. But that's
what we're tackling in this blog post: debt.
In order to understand debt, you have to understand what credit is. Credit is the ability to purchase something before you actually pay for it. It is a loan someone gives to you
based on trust that you will pay it back in the future. Credit allows us to purchase items
we couldn’t ordinarily buy because we don’t have enough cash on-hand.
Credit can be very convenient, allowing us to satisfy our needs and wants without having
to first save money. Credit allows us to get something now that we think we can afford in
the future. In this way, credit can help us out of a jam, like when you have an unexpected
big expense and you still need to buy groceries. It allows us to eventually purchase
homes, as nearly no one could ever save enough to buy a home in cash. Credit can spread out your purchasing ability over your lifetime, such as needed when attending school. If you expect a college education to raise your lifetime earning power, but you will only see that increase well after you had to pay for the education, then it can make sense to borrow.
That said, credit also allows us to make impulsive purchases for items we can’t afford, like buying an expensive car or vacation.
Such convenience is not free. You still have to pay for the items you bought, and then
you have to pay the lender additional money through interest charges and fees. This is the incentive the lender has to loan you money and to take on the risk that you won’t pay
back the loan.
Interest is charged as a percentage rate of the total amount you owe. Let’s pretend you
want to buy a new $1000 couch and you pay using your credit card. Your credit card’s
interest rate is 18% APR (Annual Percentage Rate), so if you don’t make any payments
after one year you will owe $1000 + $180. After two years, you will owe an additional
$212.40. You are paying not only interest on the original amount you borrowed, but also
interest on your previously accrued interest. This is called compound interest, and it is
one of the reasons that having too much debt can spiral out of control.
Fees can be more complicated than interest. Some loans incur significant up-front fees
such as origination fees and closing costs for a mortgage. Credit cards and lines of credit
can have annual fees regardless of whether you use them or not, and charge very large
fees if you are late making a payment.
Other loans, such as payday loans, don’t charge interest at all but force you to pay back the loan every two weeks, and if you can’t they charge a lot to open a new loan to pay back the old one. In each of these cases, you are paying for both the access to borrow money and for not having paid it back in total.
Going back to the example of the couch, if the credit card company has a minimum
monthly payment of $40, but charges 0% interest (unlikely!), it will take 25 months to
pay back the money you borrowed. But since 18% interest is charged, and interest is
charged on any previously accrued interest, you will need to pay $1263, and it will take
you an extra seven months to pay it back!
This is where compound interest comes into the picture, and where we tie credit back to
debt. If someone loans you money based on your ability to pay it back, but you are
unable to pay what you owe immediately, you are in debt. As discussed before, this in
itself is not bad, as long as you have calculated the costs, have good reason to borrow the money, and can easily pay it back over time. But with the process of compound
interest, which people often miscalculate, it can feel like your financial train to success comes off the rails. More on that in Part Two of our posts on debt, where we discuss how to get out of debt.
If you're in debt and would like help coming up with a plan to get out of it, please contact us for an appointment.
We have done it! Our new debt total is $0, which means we have no debt total! We are free and clear of those financial woes at last!
It's hard to believe we won't be making any more debt payments. Ever. Not. Ever. Again.
Here's to 2015! And here's to a fresh start! A life without debt!!
Squirrel and Nest offers one-on-one and small group financial counseling services that aim to give individuals the knowledge and independence they need to get their financial lives in great shape.