A basic tenet of personal finance that gets short shrift but can dramatically improve your money life is having a cash emergency fund.
It’s especially important for some to consider this time of year, as new high school and college graduates make their way in the world and soon-to-be newlyweds join their finances.
“Tens of millions of families struggle to afford a car repair or dental treatment because they lack sufficient emergency savings,” Stephen Brobeck, executive director of the Consumer Federation of America, said when releasing results from one of many surveys that show how poorly Americans save. The CFA study found that just 37 percent of low- and moderate-income families have a savings account. Of those who did, the median amount in it was less than $1,000.
Even parents, who are financially responsible for children, don’t save well. Just 42 percent of parents maintain an emergency fund, according to a survey by financial firm T. Rowe Price.
It sounds so simple – put away some money for a rainy day. Yet so many people don’t do it – perhaps because they don’t have a good answer to a fundamental question: Why?
“Why should I leave cash sitting idle when there are so many things I need and want?” Or, “I could invest the money and earn far more than measly bank interest.”
You only need one persuasive reason to start your own emergency fund, or add to an existing one. Maybe you’ll find one here.
• Avoid finance charges. Bad things – expensive bad things – happen, even to good people. Cars break down, roofs leak and teeth need crowns. If you have the cash to pay for life’s curveballs, you’ll avoid putting charges on a credit card and paying finance charges, or worse, taking a payday loan. If you can’t pay the bill at all, it will likely go to collections and damage your credit rating, making borrowing more expensive for years after.
• Lower insurance costs. If you have cash, you can choose higher insurance deductibles – the amount you pay before insurance kicks in – for auto and home policies, significantly and permanently lowering your annual insurance costs. Common advice is to increase your auto insurance deductible to $1,000 and raise your home deductible to $2,500.
Say no to extended warranties. Similar to insurance, having cash for repairs and replacements of appliances and gadgets allows you to forgo pricey extended warranties.
• Job loss. A robust emergency fund can help compensate for losing a job, bridging the financial gap until you can get income flowing again.
• Sense of control. Having a pile of cash can provide peace of mind and a feeling of control. Some of the worst money worries never materialize, but are conjured in our minds. Having even a few thousand dollars stashed away can relieve anxiety.
• Irregular income. For those with up-and-down income – those paid on commission, for example – a cash cushion is necessary to even out high- and low-income months.
• Give yourself options. If you have no money, perhaps you will decide against buying an airline ticket to visit a sick relative? Will you forgo an operation that could save your pet’s life? With a little extra cash, you won’t have to make money decisions you later end up regretting.