I'm sure you've heard of it - the Emergency Fund that personal
finance gurus promote. Regardless of whether or not you're
a die-hard Dave Ramsey fan, one thing remains true: Everyone
should have an emergency fund.
So, what is an emergency fund?
It's easy! An emergency fund is simply a sum of money
(we'll talk about how much later) that you have set aside, made
easily accessible (accessible within an hour or two), that is to
be used for nothing but true emergencies. We'll talk about
what a true emergency is too.
Picture this: You have an emergency come up, and you need to
come up with the $1,000 in cash within the next hour. Could
you come up with the cash - and NOT put it on a credit card?
If you can, then you're ahead of the game when compared to
Let's face it: Life happens, and when it does, it can be
really expensive! The more prepared you are, the better you can
avoid financial crisis. An emergency fund is one way of being
prepared. You don't want to learn the hard way with a
financial emergency, now do you?
Let's say that financial emergencies happen twice per year on
average, and the average cost of each incident is $500.
Even with a $1,000 emergency fund that is earning no
interest, and investments that are earning 7%, you are only
losing out on $70 per year.
Now, let's compare that $70 in interest lost to what it would
cost you to finance the same $1,000 on a credit card, because all
of your money is tied up elsewhere. According to Bankrate,
the average credit card interest rate for 2014 (so far) is
15.63%. To finance that same $1,000 on a credit card for a
year (I know, not a completely accurate comparison, but bear with
me) would cost you $156.30 in interest.
Say, for example, the Smith family has their first emergency
of the year, clocking in at $500. They do not have an
emergency fund, so they put the $500 on their credit card.
Over the next six months they struggle to pay it off and
end up only paying off $250 of it and accumulating $31.50 in
interest (approx). Then, their next financial emergency
rolls around, clocking in again at $500. Again, the Smith
family puts the $500 on their credit card. Still
struggling, over the next six months they manage to pay off $250
of their now $750 credit card balance at have managed to
accumulate $82.50 in credit card interest on their emergencies
over the course of the entire year.
The Smith Family has not yet paid off one year's financial
emergencies when they start in on the second year's emergencies.
And thus begins the vicious cycle of not being prepared for
financial emergencies and digging into impossible credit card
debt. Can you see how things can snowball without an
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