An Emergency Fund: Your First Line Of Defense

By David Berky

Downsizing, rightsizing, forced retirement, layoffs, firings, outsourcing, and being made redundant. All could mean the same thing to you: financial catastrophe.

No, you may not have to declare bankruptcy or move back in with your parents, but losing your job could put a big dent in your financial goals and even set you back several years. You may need to live on your savings or liquidate some of your investments.

If you have no savings or investments you may have to rely on credit cards and could rack up significant credit card debt. Then when you find a new job, your expenses may have increased because of the additional credit card payments.

And the job you eventually find may not pay as much as the one you lost. So you are now forced to live on less while your expenses have either continued at the same level or even gone up.

Studies show that the average worker will have six career changes in his or her lifetime. Not just job changes, but career changes. So how can you prepare for your own financial "downtime"? An emergency fund.

An emergency fund is really just savings. But it is not savings for a particular item or even an investment for your future or your retirement. It is your "rainy-day" fund. But unlike insurance where once you pay your premium, the money is out of your hands, your emergency fund is yours to keep.

So how much do you need? How can you build your emergency fund? And where should you keep the money?

The easiest way to figure out how large your emergency fund should be is to take your current income and multiply it by the number of months you could be out of work. If you make $3,000 each month and you want to be prepared for a 6 month "vacation", you will need $18,000.

But obviously saving $18,000 will take some time. How quickly you want to build your emergency fund depends on how concerned you may be about your current and future employment prospects.

Saving $100 each month will take you 180 months or 15 years. Saving more each month means you will be protected sooner. Also consider that during the next 15 years your income may increase and your expenses usually rise to match your income.

Also consider inflation. (If you own your home, your house payment may not rise. If you are renting, your rent probably will.) The cost of food, utilities and taxes also rise over the years. At a 3% inflation rate after 15 years your $18,000 will only buy $11,400 worth of goods.

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