The three rules of emergency money is a topic in David Bachâ€™s book, The Automatic Millionaire: A Powerful One-Step Plan To Live And Finish Rich where he discusses the importance of saving part of your income for the raining day, so that when there is a problem with your ability to make money, you will have something to fall back on before picking up again.
In life, there are times when we are making good money and there are other times when the money is not coming as it used to. A lot of people are usually caught off guide and unprepared for this lean time, and sadly they suffer greatly for it as they never put something in savings during the fat times.
We shouldnâ€™t find ourselves in this kind of mess if we take David Bachâ€™s teachings, which Iâ€™m sharing here, seriously. We will be happier and end richer if we secure our future today by learning how to save part of our income and growing it through methods and techniques proffered by Bach in his book, The Automatic Millionaire.
Before reading the excerpt on The Three Rules Of Emergency Money, which Iâ€™m sharing below, I want to let you know that the entire book, The Automatic Millionaire: A Powerful One-Step Plan To Live And Finish Rich delivers exactly what it promises. It offers practical steps to grow your money and secure your future financially. Itâ€™s a book you should check out.
Now, here is the excerpt from the book, enjoy it.
The Three Rules Of Emergency Money
1. Decide how big a cushion you need.
In order to be a real Automatic Millionaire, I believe you need a cash cushion of at least three months’ worth of expenses. Take what you estimate you spend each month, multiply it by three, and you’ve calculated your goal for emergency savings.
If you typically spend $3,000 a month, you want to have at least $9,000 put away in a reserve account not to be touched unless there’s an emergency. Should you try to save more? Absolutely. In my previous books, I’ve suggested putting aside anywhere from three to twenty-four months’ worth of expenses, depending on your situation. How much you should save depends on what you feel you need to “sleep well at night.” Three months’ worth is a great starting place, but if you want to go higher, by all means do what feels right to you.
With all the economic and political unrest in the world these days, a year’s worth of expenses is a great ultimate goal to shoot for. With that much saved, you don’t have to worry about making ends meet even if you lose your job and can’t find a new one for a while. Even more important, a one-year cushion gives you the freedom to make decisions about your life that you might not feel able to make now-like whether to leave a job you don’t like so you can risk trying a new career.
2. Don’t touch it.
The reason most people don’t have any emergency money in the bank is that they have what they think is an emergency every month. I want you to imagine that your emergency money is like the fire extinguisher on the wall in an office building. The cabinet containing the fire extinguisher usually bears a sign that reads, “In case of emergency, break glass.” It doesn’t say, “If you think you smell smoke, break glass.” Think of your emergency fund the same way.
The imaginary instruction sign on your emergency fund doesn’t say, “In case you really need a new dress for that special party…” or “In case the latest golf club has just gone on sale at the sporting goods store…” or “In case you want a new dishwasher because the old one is making noise…” It says, “Don’t touch me unless it’s a real emergency.”
What’s a real emergency? Be honest with yourself. You know what a real emergency is. A real emergency is something that threatens your survival, not just your desire to be comfortable.
3. Put it in the right place.
I once conducted a seminar where I talked about how important it is to have some money set aside in case of emergency. In the middle of my discussion, a gentleman named Bob sitting in the back of the room raised his hand. “David,” he said, “I’ve got $60,000 in emergency funds put away. Is that enough?”
“That depends,” I replied. “How much do you spend each month?”
”About $2,000,” came the answer.
“So you’ve got thirty months’ worth of expenses put away,” I said. “That’s a HUGE emergency fund by any standard. Why so much?”
Bob grinned an embarrassed sort of grin. “Well;’ he said, “you know, my wife and I worry about the possibility of another depression, or maybe a war. My wife even worries about UFOs.”
The class started laughing.
“No, no,” I said, quieting them down. “Remember, the point of an emergency fund is so you can sleep well at night. If having sixty months’ worth of expenses keeps Bob and his wife from worrying about UFOs, then that’s the right amount of money for them to have saved.” I turned back to Bob. “So tell me,” I continued, “how much interest are you earning on this money?”
Bob’s answer stopped me in my tracks. ”I’m not earning any interest on the money,” he said. ”I’ve got it buried in my backyard in a suitcase.”
I stared at him in disbelief. “You’ve got $60,000 in cash buried in a suitcase in your backyard?”
“Well, it’s really more like $65,000,” he said. “There’s some gold coins in the suitcase too.”
At this point, I was speechless. In the silence that followed, someone in the front row turned to Bob and said, “Out of curiosity, where exactly do you live?”
The class broke up completely. It was one of the funniest moments I’ve ever experienced in a classroom. People were laughing for minutes.
All the same, however, Bob’s story troubled me. No way was he one of a kind. It’s not that I thought there were lots of people burying their money in suitcases. But there had to be thousands, maybe even millions of people out there putting aside money for a rainy day without earning any interest on it. And that’s almost as bad as what Bob did.
You heard me right. Not earning interest on your emergency money is almost as bad as burying it in your backyard.
MAKE THE MOST OF YOUR EMERGENCY FUNDS
When most people set up emergency funds, they put their “rainy day” money in savings and checking accounts. Why is this a bad deal? Because most savings and checking accounts pay little if any interest. In fact, most of these accounts can even cost you money-what with monthly fees, ATM fees, check fees, visiting the branch fees, and so on.
The point is that whatever you do with your emergency money, find a bank you can trust that will take care of your money but will also make it grow. What you want to do with your emergency money is put it in a money market account that pays reasonable interest.
A money market account is one of the simplest and most secure alternatives around for anyone who wants to put aside some cash and earn a reasonable return on it. When you make a deposit in a money market account, you are actually buying shares in a money market fund-a mutual fund that invests in the safest and most liquid securities there are: very short-term government bonds and sometimes highly rated corporate bonds. Just a few years ago, you generally needed a minimum of as much as $10,000 to open a money market account. Because of this, many people still mistakenly think these accounts are for the rich. In fact, you can now open most money market accounts with a minimum deposit of between $1,000 and $2,OOO-and in a few selected cases with as a little as one dollar. That’s right-just one dollar.
SHOP FOR A RATE LIKE YOU’D SHOP FOR A CAR
These days, there are literally thousands of money market accounts to choose from, and like everything else, the cost and quality varies widely. So, just as if you were buying a car, don’t be afraid to shop around.
Perhaps the most important variable is the interest rate different money market accounts pay. Not only is there a huge variation from bank to bank, but rates can and do change daily.
Since the early 1990s, interest rates in general have been dropping steadily-and along with them so have the rates paid by most money market accounts. Over that time, I’ve seen them go from about 12 percent a year to a solid 7 percent in the 1990s to 1 to 3 percent as of this writing (in early 2005).
FINDING THE RATE MONEY MARKET ACCOUNTS ARE PAYING
To get an up-to-date look at what rates are available, here is what you should do.
1. Get a copy of a financial publication such as the Wall Street Journal, Investors Business Daily, or Barron’s. They all offer extensive lists of what interest rates different money market funds are paying. Similar information (though not quite so detailed) can also be found in USA Today or possibly even your local paper.
2. Go to www.bankrate.com if you have access to the internet. This web site not only allows you to compare money market rates being offered by different institutions but also indicates the minimum deposit each requires to open an account. In addition, it allows you to sort banks by state, which is important since some banks can offer tax-free checking and money market accounts, depending on which state they-and you – happen to be in.
NOW CALL YOUR BANK
Once you’ve gotten an idea of what kind of rates are available, you’ll be in a better position to question the institution that is currently holding your rainy day money. If it’s a bank, pick up the phone and call them. Ask what kind of interest your money is earning. If the answer is zero, ask if they offer money market accounts. If they do, ask them what you need to do to open one and how much interest it would pay. Then compare the rates to what you’ve seen elsewhere.
Based on this comparison, you may decide that it makes sense simply to move your emergency funds from the non _ or low-interest-bearing account they’re in now to a money market fund at the same bank. If this turns out to be the case, keep in mind that all it took for your money to start earning interest was for you to start asking the right questions.
Why didn’t the bank tell you this information earlier? What do you think? This is why knowledge is power.
Remember, the rich get rich because they make their money work for them. Now it’s your turn to do the same.
FOR AN EVEN BETTER DEAL, CHECK OUT BROKERAGE FIRMS
In most cases, you can get a higher yielding money market account at a brokerage firm than at your local bank. There are many reputable brokerages that offer money market accounts. The list on the next few pages is not exhaustive, but it’s a great start-and more than likely contains enough leads for you to be able to make a decision.
When you contact a brokerage firm, ask the following questions:
1. What’s the minimum to invest?
2. Can I set up a systematic investment program where you take money out of my checking account on a regular basis and invest it in a money market account? (Make sure they can do this automatically.)
3. If I set up a systematic investment plan, will you lower the minimum to invest?
4. Do you offer federally insured accounts? What’s the rate on your insured money market accounts vs. your regular money market accounts?
5. Does the account come with check-writing privileges, and if so, what’s the smallest check you can write? Does it come with an ATM card? (Even though you’re not going to use your checks or ATM card except in an emergency, it’s nice to have them in case you ever need quick access to your funds.)
6. Does the bank charge a low balance fee? (Some accounts hit you with an extra monthly or annual fee if you dip below a minimum. Be sure to ask for details.)