Emergency Fund

One of the initial financial goals I would recommend to people is to set up an emergency fund. This may seem counter-intuitive, especially if they are carrying hefty credit card debt at outrageous interest rates. Wouldn’t the money be better spent paying down the debt? I think a balance between the two is ideal.

Life happens. Your car breaks down and needs a new transmission. A family member or child falls ill and you have to take time off without pay to take care of them. You need to get your wisdom teeth removed and your employer’s health insurance only covers 50%, and you’re responsible for the rest. Or, your company restructures, and you find yourself without a job.

If you are living paycheque to paycheque, you will be scrambling to make ends meet. Without an emergency fund, you will be forced to rely on credit, whether it is from your line of credit, your credit cards, or even those evil cash advance places. These sources may provide the additional funds required make ends meet in the short term, but you may end up paying for those expenses for years to come.

How much?

Experts usually recommend 3-6 months of living expenses. How much is that? If you have a budget, you would know exactly how much money you would want to target for this account.  😛 If you have never had an emergency fund, start with whatever you can. Set up an account that will automatically withdraw a certain amount from every paycheque. Even $20 helps. See if you can slowly increase this amount once you get a better handle on your finances.

WARNING

The biggest issue with a hefty emergency fund is that the definition of emergencies becomes more and more interesting.

Example 1. Problem: I am so stressed!

Solution: I need to head to Vegas or to the beach somewhere hot.

Reality: I want to party. This is not an emergency.

Example 2. Problem: I want to save money but still have fun!

Solution: I should buy a hot tub or a pool table. I will spend more time at home with friends and save money!

Reality: I want to party. This is not an emergency.

Example 3. Problem: I have been working sooooo hard!

Solution: I deserve a new outfit or a new tv or a day at the spa.

Reality: THIS IS NOT AN EMERGENCY

You get the idea. Ultimately, the goal with an emergency fund is to have a bit of money set aside in case sh*t happens. It will happen. But when it does, you won’t have to rely solely on credit to deal with it.

Do you currently have money set aside for an emergency fund? Would this be a good thing to add to your list of financial goals this year?

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Compound Interest: 8th Wonder of the World!

There are lots of excuses to justify why one may not have enough money for savings or an investment plan to prepare them for their retirement. I’ve often told myself that I would rather go try out that nice restaurant, or I need to be on a beach somewhere, or I just need another purse. It’s easy to promise yourself you’ll start saving tomorrow, but that tomorrow will end up being next week, or next month, and eventually next year. Unfortunately, not only are you sacrificing your future for immediate satisfaction, you’re also giving up on the magical powers of compound interest. Simply put, it’s the ability to earn interest on your interest. For example, if you put $10,000 into a savings account at 1.5% interest, you will earn $150 at the end of the year. If you leave all that money in the savings account and don’t touch it, at the end of the second year, you will earn $152.25 for doing absolutely nothing. “An extra $2? Whoop dee do!”

Let’s look at this in a different way. You have to choose between the following 2 scenarios:

  1. Starting January 1 until January 31, I will give you $20,000 a day; or
  2. Starting January 1, I will give you a penny. Every day after that, for the rest of January, I will double the previous day’s amount.

Which one would you choose? The $20,000 a day sounds pretty good, hey? That’s $620,000 by the time January 31 rolls around! But if you took that second deal, where the value doubles every day for a month, what would you end up with on January 31? Over $10.7 MILLION dollars!

So the Level 3: Savings Cheat of the Day? Start saving today! Start early in life, preferably in your twenties, but if you’re a bit “more mature” than 20, then today is the next best time to start saving.

How does starting early help you? To help illustrate the magical powers of compounding, the following table is a summary of the annual amount of savings required to be a millionaire when you retire at age 65. The table assumes an annual compounding interest rate of 10%.

Age When You Start Saving

Annual Investment to Retire a Millionaire at Age 65

20

$1,150

Under $100 a month!

25

$1,870

30

$3,040

Around $250 a month!

35

$5,000

40

$8,330

Around $695 a month!

50

$25,300

60

$117,830

Not retiring with a million bucks. 😦

Depending on how old you are, the amount of money required may seem intimidating. Remember, every little bit counts. You have to start somewhere, and gradually increase the savings amount from there.

So what’s the Level 3 Savings Cheat of the Day? Start saving TODAY! Have a good weekend!