I am a firm believer in an emergency fund. I tell others about the benefits and why they need one. I have it as part of my long term plan. I just don’t have a fund right now. Lazy Man and Money is Glad he has an emergency fund. I am glad i don’t have a fund right now. Dave Ramsey advocates having a $1000 emergency fund first. My wife and i are working on our credit card debt first. So why don’t we follow this advice yet?
The costs of an emergency fund
The first cost of an emergency fund is the fund itself. If you have a $1000 emergency fund your first cost is $1000. If you have credit card debt putting $1000 in to a savings account is no different than taking a $1000 loan against your credit card. This $1000 is keeping me in debt longer. It is $1000 not going to pay down my debt. On our plan this is now 2 1/2 months longer with credit card debt. Had we started when we first began working to become debt free this was almost 6 months longer.
When paying down debts you pay down the lowest balance or the highest interest rate. We chose the highest interest rate. An emergency fund equates to a loan of $1000 at the highest interest rate. The rate on this emergency fund loan drops each time you pay off your highest interest debt. Each month i don’t use that $1000 toward debt lengthens the time i will be in debt.
When an emergency hits what happens? There is no difference to my finances with or without this emergency fund. If i have a $500 car repair hit and don’t have an emergency fund this bill gets added to my 8.24% interest rate card. If i pull this out of my emergency fund i add $500 back to the fund before paying extra on my cards again. This leaves the credit card with a $500 higher balance until my emergency fund is replenished. Either way i pay the interest on the $500 on the credit card bill. Six in one hand, half dozen the other.
Having an emergency fund is an insurance policy against trouble. It protects you from paying interest on these emergencies. Until you are out of high interest debt the costs are the basically same. Insurance is a gamble against yourself. Life insurance is a gamble that you will die. Car insurance is a gamble that you will be in an accident. Health insurance is a gamble that you will have health problems.
When to start the emergency fund
Hopefully never. Wait, never? With some advance planning you can have an ING Savings fund for health costs, car repairs, lost job, etc along side your vacation fund. Since most people don’t want to plan that much in advance they lump all of these into one “emergency fund”. Even i don’t want to plan that much so i too will opt for the emergency fund. If you were going to have these separate funds you don’t start until your debt has been paid down. Using a lump “emergency” fund then i suggest starting at this same point. Don’t take a loan against yourself.
What do you think? When do you start your emergency fund?