Your emergency fund should be for an EMERGENCY! Not, “I really, really want to go to this concert,” or, “I really need a diamond studded dog-collar for Tinkerbell.”
Everyone’s definition of an emergency is different. But, if you want it to be of some use to you, you need to have a strict definition of an emergency.
Your emergency fund is what you should turn to when “life happens.” It will be what you turn to rather than your credit cards.
Also, your emergency fund should put more dollars into your pocket once it has been well established. Here is how:
1. You start putting $100 a month into a high-yield savings account. This will not generate much income, but it will do a whole lot better than spending the money.
2. After a five months, barring no emergencies, you will have $500 in your high-yield savings account earning a nice interest rate. Now you can call your car insurance company and ask them to raise your deductible from from $100 to $250. Since you have $500 set aside for an emergency, you will now be able to afford the $250 deductible.
3. The good news is that when you raise your deductible, your insurance bill goes down. Now that you are saving $120 a year on your insurance bill, you can add that to your emergency savings. Instead of saving $100 a month, you can now save $110 a month ($120/12 months=$10) with no extra money out of your pocket.
4. Now that you are adding $110 a month to your emergency fund each month, it will grow even faster. In a few more months, you will reach $1000 balance. You can call the insurance company again and ask them to raise your deductible to $500. Again, this will lower your insurance bill even more. Add the difference to your emergency savings and keep this cycle going.
5. As you can see doing this over and over again will save you money, while expanding your safety net. Your bank account will be growing at a faster pace and you will have more peace of mind.
The figures used are hypothetical and I would suggest raising your deductible only to a level that you are comfortable with. But remember, you are paying a lot of money to the insurance company to have a low deductible.
Keep letting your emergency fund grow larger and larger and shoot for a dollar amount that would cover 3 months of your living expenses. Once you get to that point, then you should start looking at investing in mutual funds or stocks to get a better return on your money.