First Priority: An Emergency FundYour first priority should be to establish an emergency fund. The money you save in your emergency fund will pay for living expenses if you are laid off from a job or you have an unexpected expense, such as a major car repair bill. The emergency fund could also pay your expenses if you must quit working and you are waiting for Social Security or another disability plan to kick in. Think of money in your emergency fund as available only when there is no other way to pay for something that is a necessity.
Most financial advisers will recommend having three to six months' worth of income set aside in your emergency fund, but when faced with a health problem that can cause disability and large out-of-pocket medical expenses; you should consider keeping a larger emergency fund. To determine how large your fund should be, think about how much money you would need to bridge any gaps in income if you were to become disabled. Also think about how your monthly living expenses may increase down the road if your health worsens. Add these additional amounts to the generally recommended three to six months of cash, and then invest this amount in a savings account or money market fund that can be converted easily to cash.
Ideas for starting and building an emergency fund:
- Pay yourself first. If you have a job, take a certain amount of money out of each paycheck ($10, $25, $50) and put it into a savings account before you pay any other bills. Leave the money in the account until you face a real emergency.
- Put "extra" money into the emergency fund. This extra money could include tax refunds, job bonuses, overtime pay or raises. When you pay off a bill, continue making the same payment-but pay it to yourself in a savings account. Another easy way to save: Put $1 a day plus your loose change in a jar. By the end of the month, you may have $50 or more to deposit into your savings account.
- Plug spending leaks. Find ways to cut back on spending, and put what you save into your emergency fund.
When you reach your emergency fund goal, start a new savings account for other short-term goals, such as buying furniture, taking a vacation or enrolling in education or training classes. Or, consider investing money in stocks, bonds or mutual funds for long-term goals, such as saving for a house or your retirement. The real power of money is that it can grow dramatically over time-if you save it in the first place. If your job offers a retirement plan, take advantage of it. It's one of the best ways to save for retirement, especially if your employer matches all or part of your contributions. You also get special tax breaks for saving in a retirement plan. If your company does not have a retirement plan, set up your own Individual Retirement Account (IRA) and contribute money to it every year.