I have gone back and forth on the emergency fund issue. Should I focus on paying off my debt first and THEN start building up my savings? Or should I build up a cash cushion before I focus on paying down debt. There are many schools of thought on this issue. Some say that having an emergency fund when you have debt is stupid. Why have a large amount of cash available when you have large amounts costing you interest? Others argue that you never know what may come up and you have to be prepared. Here’s a snapshot of the journey I took to reach my current philosophy.
First Pay Others THEN Pay Yourself.
I admit it. I bought into the hype. Why have $2000 sitting in a checking or savings account earning $0.10 a month when you have $20,000 worth of debt charging you $100 (or more) in interest every month. It just didn’t make sense to me. At this time, I basically had a zero based budget. Every single penny was accounted for and if I ever underspent in any category, that extra went straight to my debt. I felt focused and in control. That is, until I got a $600 gas bill. I panicked. I didn’t know what to do because my budget for emergencies ($80) that seemed extravagant was merely a pittance. Because I had been throwing the extra I had at the end of each month at my debt, I had no extra money whatsoever. At this point, I changed my tune.
First Pay Yourself THEN Pay Others
The above incident plus some other factors made me see the importance of having money that was “just sitting around.” I realized at this point that if I lost my job (not so far fetched in this economy) I would not be able to pay my next months rent. I realized also that I had forgotten to put my car insurance in my budget (I used to pay it off in one month or 2 so I forgot about it) and it was about to be renewed. I’m not sure how insurance works for everyone but I have to cough up 3 months worth in the first month (then I get the last 2 month payment free). I didn’t have that money. I thought about things and decided that my debt was not going to be paid off in a matter of months. It was too optimistic and naive of me to believe I could live so frugally and hand to mouth for 3-5 years. I decided that the little I would save in interest by paying my debt off faster was not worth the stress. At this point, I felt that being debt free in 4 years would feel the same as being debt free in 4.5 years. So I reworked my budget. I reduced how much I paid to my debt and increased my savings. I really wanted to have at least a months rent + expenses saved up.
Somewhere in Between
Today, I fall a little bit in the middle. I found that when I saved a lot for emergencies, so many things suddenly became “emergencies” and I would dip into my savings for it. They were not large amounts but it’s silly to divert money from paying down debt in order to save and then use that money to fill your tank. If I didn’t have that money available in savings, I just would not have gone wherever it was that I “needed” to go or I’d have found someone with a car. Nowadays I’m working towards having 1-2 months expenses and rent saved up. I know most advisors advocate 6 months living expenses saved up but that just does not work in my situation. It won’t make sense for me to have $20,000 sitting in my bank account at my debt level. The way I work it, whenever my savings grow significantly over 2 months expenses, I put that excess towards my debt. That way I’ve been equipped to handle emergencies (believe my you will have some) but I also am working on my debt. It’s obviously slowed down my debt payment progress but I feel more secure. You have to just find the balance that works for you.
Everyone reading this should go and ask themselves this question. “If I lost my job today, would I be ok for at least a month?” If the answer is no, you should really start contributing to an emergency fund – even if it means paying the minimum on your credit cards for a couple of months. Believe me, it’s worth it.
{ 3 comments… read them below or add one }
It is suggested that the recession could continue for years – like the Great Depression or “the lost decade” in Japan – because the remedies being used (e.g., near zero interest rates, massive deficit spending, and bail outs for collapsing firms) will perpetuate the underlying problems instead of solving them. Time will tell, but I am inclined to agree that there could be another dip in 2010.
I think it depends. in my situation im so far in debt at about 20,000. yes paying down the debt would be the thing to do but if its a debt where it wouldnt help you if you got into a tight spot and needed the spare cash then you’re that much more stuck in debt. but lets say my car breaks down and i have no emergancy money to help fix it. in my case because i have no er funds, i would then lose my job and have no money to pay down my debts any further. ok so now im 15,000 dollars in debt instead of 20,000, my job is gone cause i cant fix my car and now my debt will slowly increase again due to interest. which would make it where now not only do i not have a job and no way to pay my debt down but my debt will be right back to where it was due to interest and now i have no way to pay it down. where if i had an ER fund i could at least been able to fix my car and continue paying on my debt little at a time. thus the difference between 2,000 in savings VS 20,000 in debt for smaller ppl like myelf.
That’s why I’m following Dave Ramsey’s advice to have a $1000 baby emergency fund while paying down debt.
It’s not so much that I become careless with spending, but it is enough for when I needed tires 2 months into the program and didn’t have enough in the sinking fund I could get them.