Today’s money hack is related to saving money for emergencies in order to prevent accumulation of debt.
With debt being labelled as a modern day equivalent to slavery, it is crucial to do everything in our power to stay debt free. Few rational adults would willingly accrue masses of debt that they are unable to repay quickly yet millions of people are trapped in debt that threatens to financially cripple them. The debt monster has led many people to resort to criminal activities or worse, end their lives to rid themselves of the burden.
The reality is, life is full of unexpected twists and turns, more so for people at the bottom of the pyramid. At every step of the way, consumers may feel the need to rely on to some form of debt to cover their expenses. Some of these expenses may be foreseeable, such as school tuition, groceries and utility bills and to meet these expenses, one should, ideally, manage their finances in such a way that they do not have to rely on credit cards or other forms of consumer debt.
However, other types of expenses may pounce upon you rather unexpectedly. A weather storm may damage your house’s roof, a road accident may damage your car, you may develop a serious health issue or get laid off from your job. Many people quickly accumulate a lot of debt trying to cover these expenses and sometimes go bankrupt.
This is where the concept of an emergency fund comes in…
Emergency fund – definition, size/amount and maintenance
To meet these unexpected expenses without losing all your assets and hitting a financial sinkhole, you need an emergency fund. This is essentially ‘backup money’ that will keep you away from debt, to whichever extent possible.
Many personal financial bloggers will tell you that the benchmark amount in your emergency fund account should be around 5 or 6 months’ worth of expenses. To simplify it further, you can place half a years’ worth of salaries in the emergency fund and then walk away from the money money until you really, REALLY need it.
Once you have this money in place, add to it over time. If and when you do end up using the money from your emergency fund to meet a big ticket expense or every day expenses, replenish the amount as soon as possible. Dave Ramsey advises it is better to keep the emergency fund in a liquid state, i.e. cash in a bank account you can access quickly in your time of need. However, people differ over where to keep one’s emergency fund.
Read more about building an emergency fund at Investopedia.