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Spending smart: Save your way to soft landing in emergencies

A basic tenet of personal finance that gets short shrift but can dramatically improve your money life is having a cash emergency fund.

"Tens of millions of families struggle to afford a car repair or dental treatment because they lack sufficient emergency savings," Stephen Brobeck, executive director of the Consumer Federation of America.

It sounds so simple: Put away some money for a rainy day. Yet so many people don't do it — perhaps because they don't have a good answer to a fundamental question: Why?

Here are some good answers to that question:

Avoid finance charges. Cars break down, roofs leak and teeth need crowns. If you have the cash to pay for life's curveballs, you'll avoid putting charges on a credit card and paying finance charges, or, worse, taking a payday loan. If you can't pay the bill at all, it will likely go to collections and damage your credit rating.

Lower insurance costs. If you have cash, you can choose higher insurance deductibles for auto and home policies, significantly and permanently lowering your annual insurance costs.

Say no to extended warranties. Similar to insurance, having cash for repairs and replacements of appliances and gadgets allows you to forgo pricey extended warranties.

Job loss. A robust emergency fund can help bridge the financial gap until you can get income flowing again.

Sense of control. Some of the worst money worries never materialize but are conjured in our minds. Having even a few thousand dollars stashed away can relieve anxiety.

Irregular income. For those with up-and-down income — those paid on commission, for example — a cash cushion can even out high- and low-income months.

Give yourself options. If you're broke, you might make decisions you later regret, such as not visiting a sick relative.

Frequently asked questions

How much do I need?

Typical advice is cash equal to three to six months of bare-bones expenses — food, shelter and utilities. But that dollar figure can be overwhelming. Start with intermittent goals, such as $1,000, $2,500 or enough to pay four months of the mortgage or rent.

Where does it fall among money

priorities?

It's a good idea to start with a small emergency fund, say $1,000 or 2 percent of gross household income. But then turn attention to high-interest debt, such as credit card balances, before returning to the goal of beefing up the emergency fund.

Does it have to be in cash?

Preferably. Cash gives you the most options and is quickly available. But when trying to safeguard against job loss, which requires a much bigger fund, consider unused credit on credit cards, home-equity lines of credit and even potential borrowing from family.

Where do I keep it?

Ideally, you would keep cash in a separate account. Consumer behavior studies show we're more likely to keep our hands off it for discretionary spending because of "mental accounting."

Where do I get the money?

Fund it with automatic contributions — an electronic transfer from your checking account on payday, for example. Also fund it with lump-sum windfalls, such as a portion of your income tax return.

Spending smart: Save your way to soft landing in emergencies 05/12/13 [Last modified: Sunday, May 12, 2013 5:14pm]
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