We all know of people who have faced a financial crisis. Many of us have experienced it ourselves or seen someone in our immediate family go through it. John has a great job, getting paid a modest income. He’s the best worker in his department. He knows that his job is completely secure. But then the unthinkable happens. New tax laws require his employer to cut back the staff. Despite being the best employee, non-discrimination procedures cut him randomly.
Jill works as a paralegal for a small law firm, also making a decent salary. Financially, the company has no problems. On her way to work one day she is in a car accident. Her recovery requires that she be out of work for three months, but her sick leave only allows two weeks. Same story.
The Problem with Emergency Funds: Not Enough People Have Them
While none of us think this could happen to us, an average of nearly 15 million people were out of work collecting unemployment in 2010, according to the US Department of Labor. This number reflects the people who were out of work at a particular time, not the total number of people out of work. This also does not take into count the number of people who were out of work due to medical reasons or were out of work for so long they could no longer claim unemployment benefits. With nearly 10% out of work at a given time in 2010, one could only imagine the number of families this affects in a 10-year period.
So what is the solution? According to Rutgers University, 70% of these types of families dipped into their retirement funds between August 2009 and March 2010. Fifty-six percent borrowed from family or friends. Forty-two percent of families decided their healthcare could be sacrificed, and 20% of people moved out of their homes, hoping families or friends could house them for a while. What’s worse, 45% of families decided credit card debt was their solution.
You Need an Emergency Fund
While these choices may be acceptable to some, others have followed the advice of financial experts such as Dave Ramsey and Crown Financial Ministries by setting up an emergency savings fund — even in the midst of their personal disasters. In essence, an emergency savings fund is any type of account that holds funds for an emergency. Crown recommends a minimum of 3 months worth of living expenses (ideally 6 months) set aside for true emergencies — the kind of scenario where someone looses a significant portion (or all) of their income or has dramatic, unexpected expenses.
Understanding the need for an emergency fund is the easy part. It’s pretty simple to see the risk of losing a portion of one’s income or having an unexpected expense arise. Knowing how to set one up can be a little more difficult. Given volatility in the stock market right now, it would not be the worst idea to stuff three months worth of income in an envelope and put it between your mattress and box spring. However, while being fairly safe and liquid, this envelope-under-mattress method will only devalue in line with annual inflation rates.
Places to Put Your Emergency Fund
There are three primary types of places to store an emergency fund: banks, credit unions, and money market mutual funds. The idea is to put your money into these accounts specifically for emergencies and not touch it otherwise. However, you never know when emergencies will pop up, so you want to have access to the money fairly quickly. I’m not a financial advisor, but here’s a quick rundown of places you might think about storing your emergency fund.
Banks are the most convenient option, but they are also usually the accounts with the smallest monetary yield. As a PerkStreet customer, I’m excited for them to finish preparing their savings accounts and launch them, since that will make the company even more convenient. The rate of return on savings accounts can be lower than .05%, but the convenience of them is that they don’t require a minimum balance, which is great for starting off.
While savings accounts are limited regarding account debits, there is no limit on the account deposits. If you can only afford to put $5 a month into the account to start off, then put $5 a month into the account to start off! That first step of $5 per month will add up over time, and having some funds in case of an emergency is better than not having any at all.
Certificates of Deposit (CDs) generally offer a higher yield, but tend to have higher penalties for unscheduled withdrawals. Money Market Accounts (not to be confused with Money Market Mutual Funds) also tend to give a higher interest rate, but they tend to require a higher minimum balance. However, these are some options you can look at, as rates and minimum balances vary constantly, and some CDs can be for a relatively short period of time — even a few months.
Credit unions offer similar products to banks, but they tend to yield slightly higher interest rates. Credit union accounts aren’t covered by FDIC insurance like PerkStreet’s accounts are, but they are covered by the NCUA. Just like the FDIC, the NCUA covers all credit union accounts up to $100,000 per member per credit union with provisions for $250,000 for certain retirement accounts.
A third option, in addition to credit unions and banks is a Money Market Mutual Fund. A Money Market Mutual Fund is a collection of debt securities where the investor is taking a minimal amount of risk by purchasing stock in a particular fund. This fund deals with a large number of securities so that the investor doesn’t have a great deal of risk. (It’s a diverse investment.) The interest rate is usually somewhat higher than a bank or a credit union, but there is always a chance you’ll lose your money when it’s in a Money Market Mutual Fund.
The risk for unexpected loss of income or unexpected expenses is very high for all of us, regardless of our age, health, or job status. Yet when these unexpected events occur, you don’t have to leave it up to chance as to what happens to your lifestyle. Taking a few small steps and setting a small amount aside on a regular basis can help build a resource that will be there when you need it. This way, you won’t end up making drastic financial decisions if something unexpected does pop up as it does for so many people every year.
Jeremiah K. Garrett is a PerkStreet customer and a graduate student working on a Master of Arts in Biblical Studies at Asbury Theological Seminary in of Orlando, Fla. He works from home, running Eyez4Dizney, an eBay store selling media, electronics, and collectible items. Jeremiah has been married for seven years, has a two-year-old son, and has a daughter due this summer.
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