Spending Plan & Emergency Fund 101

LightsLast time we touched on spending plan surprises, those expenses that aren’t fixed and routine. Things like unexpected car repairs or special anniversary gifts that can derail your cash flow. This seems to be a great time to talk about building an emergency fund. Back before the economic meltdown, financial advisors recommended a reserve at least six months and optimally up to 18 months. For those of us who live in the Bay Area, we scoff at this seemingly insurmountable figure. Realistically, in light of layoffs and other employment challenges, many of us need this safety net when looking for a new position or transitioning into a new career.

Regardless of what emergency fund dollar figure you use, here are some tips to begin feathering your nest egg:

Spending Plan Mantra: pay yourself first.

I suggest opening a special savings account just for the purpose of an emergency fund. Once you have built up enough funds (higher balances, higher interest rates paid to you), then to migrate up to a money market account. Then rinse and repeat. Keep adding to the fund until you reach a level where it warrants another investment vehicle that’s liquid.

DropYou can start out as small as $20 a month. Have it transferred automatically so you don’t see it… and therefore don’t spend it. As time goes on, like when you get a raise or much-deserved bonus, then squirrel away maybe 60% of it. Use 40% for a splurge or increase your monthly cash flow. The important point here is to set aside a percentage or dollar figure every month. I won’t quibble over the specifics, but definitely pay yourself first!

Note: 401(k) funds should not be considered a rainy day fund. The penalties are simply just too high. The hallmarks of an emergency fund is liquidity, easy access when you need it most.

Economize where you can.

The last several posts have been around creating a realistic spending plan. Stay on top of your spending habits. If you find you’re not putting money aside each month (hint: pay yourself first), then look at the areas where you can economize.

We’ve now officially entered the last quarter of the year. The holidays are right around the corner. No doubt, the last thing on your mind is filing next year’s taxes. However, now’s the time to put together your strategy. Make an appointment with your tax professional to make projections, and to discuss any strategies for reducing tax liability (e.g., like cleaning out the garage for year-end donations).

What strategies have worked for you in building a rainy-day fund?

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