Winter 2004-05
Count on it: Throughout your life, you can expect the unexpected. And when those surprising events result in unplanned expenditures, they can wreak havoc on your budget.
Think about the events of your life during the past year or two. Did you get a speeding or parking ticket? Did you have unexpected car repairs? Was your pet sick or injured and required treatment from the vet? Did your child need braces? Did your water heater need to be replaced?
Life events often seem to occur when you are the most vulnerable. So isn't it wise to act as if life's next little surprise will not be a surprise at all, but an eventuality?
Let's take Brendy. She did not think much about the future and certainly didn't consider making a financial contingency plan for life's emergencies. Brendy concerned herself only with the here and now.
Her here and now revolved around Brian, her military husband. Brian's training had provided a host of practical skills to build his military career - and, potentially, a future career in the civilian working world. He had taken several college courses through the military and was nearing completion toward a degree.
Meanwhile, Brendy had a part-time job making lattes at a nearby Starbucks. She had never given her education or career path any serious consideration, and she was content with her current situation.
Unfortunately, Brendy's perfect world crumbled after the stress of military life gradually led to a divorce. Not only did Brendy lose her husband, she lost his income as well. Brendy would need to find a better job, but she had no idea what she wanted to do. She wound up moving back home with her parents, and felt so panicked that she took the first job she could find.
Without a financial safety net - an emergency fund - in place, the options for escaping a monetary predicament are limited. If you are unemployed or underemployed, as in Brendy's case, you may be forced to supplement your income by working two or three jobs.
Much of Brendy's sorry situation could have been avoided by preparing a strategy for life's unexpected events.
Confronted with bills that your income cannot cover, it makes sense to turn to your savings. However, the average American saves a mere two percent of total income. Such paltry savings might cover a parking ticket, but what about a major car repair? If you don't have money you can easily access without penalty, you may be forced to choose from several undesirable options.
One option may be to pull money out of an IRA or other retirement fund, if you have one. But the money in these accounts should be considered untouchable, earmarked solely for your retirement years. You may be able to draw money out early but the penalties, which include early withdrawal fees in addition to being taxed on the disbursement as income, are substantial.
Another undesirable option may be to use credit to finance the life event. If you don't have the cash to pay for a new washer and dryer, for instance, you may finance your purchase. It's tempting to use credit to pay for items you can't afford. But be warned: If you make only the minimum payment when you receive the monthly bills for the financed item, your purchase will become far more expensive due to the added cost of interest. If you must use credit, always try to pay more than the minimum when you receive the bill each month.
Easily the most desirable option is to have a savings cushion in place that is equal to three to six months of your monthly expenditures. If your expenses are $2,000 a month, you should have $6,000 to $12,000 in an accessible account such as a bank savings, checking or money market account.
With a financial safety net in place, life events will not cause such desperation. If Brendy had looked to the future and set aside some savings, she could have had the option of renting an apartment, she could have improved her education and she could have taken more time in her job search.
And ultimately, she would have been much happier. There's nothing like the peace of mind that comes from the knowledge that you have emergency money on hand to provide a temporary reprieve from life's unexpected events.
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Dara Duguay is Director of the Office of Financial Education for Citigroup and the author of several self-help financial books. Her most recent is "Don't Spend Your Raise: And 59 Other Money Rules You Can't Afford to Break." Her books may be found at www.amazon.com or at any major bookstore.