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Personal Finance

Why budget?

2015-04-27

Life happens. The car’s transmission breaks. Athletic children break their ankles. A distant funeral must be attended. All these unexpected events are part of life, but should not have to bust the budget. A sound financial plan should include an emergency fund, which provides readily accessible cash to pay for immediate, urgent requirements.

What is an emergency fund?

An emergency fund is a category of savings dedicated exclusively for urgent, unplanned expenses. With an adequate emergency fund, money will be available for disasters and adverse events without having to use credit cards or taking out a loan to meet the financial need. Thus, an emergency fund helps provide a peace of mind that a military family can meet an urgent need without destroying the budget or tapping into retirement savings.

How much money should be kept in an emergency fund?

Most financial advisors recommend that an emergency fund be between two and six months of living expenses. For a military family with a good credit history, two months base pay should be a sufficient emergency fund. However, for a family with weak credit, a poor health history, or a complicated financial situation, six months’ worth of expenses would be more prudent.

For example, a military family that has $2,000 per month in necessary living expenses should set aside between $4,000 and $12,000 in an emergency fund. Here is the breakdown of this imaginary family’s necessary living expenses:

Mortgage/rent:$1,000
Utilities:$250
Food:$350
Insurance:$100
Fuel/transportation:$200
Phone:$100
Total:$2,000 2 mo. X $2,000=$ 4,000
6 mo. X $2,000=$12,000

Where should I keep the emergency fund?

The guiding principle for emergency funds is that you want to have quick access in the case of an emergency, thus you want to save the funds in a liquid account. Bank and credit union savings accounts are ideal for emergency funds. Some financial institutions also offer high-yield savings accounts, certificates of deposit, and money market funds that may earn slightly more interest. These accounts are suitable for an emergency fund, as long as the institution places no restrictions on how quickly you can access the cash. Ideally, your emergency fund account would have check writing privileges.

I don’t have an emergency fund. Where should I start?

An emergency fund is a foundational part of a sound financial plan. Once your plan is established, and your budget understood, you should first save towards a $1,000 emergency fund. Saving $100 per month will reach that goal in less than a year. The next step would be to reach an emergency fund of two months’ living expenses. For our example above, this would equal $4,000. By saving $200 per month, you will reach this next goal in 15 months. By consistently saving a small amount towards your emergency fund, you will have achieved the minimum recommended emergency fund in two year’s time, and placed yourself in a more secure financial situation.