[Excerpts from this post are taken from Larry’s book, Beyond Peace In Christian Finances: Accelerating Past Average With Your Money Plan]
In Financial Peace University, Dave Ramsey teaches the basic “three to six month’s worth of expenses in a good money market account.” But the preparation ends there at the Baby Step 3 Emergency Fund. I’m not knocking this advice, because I think it is good advice. My family has a rainy day fund such as this for unexpected financial problems.
What happens, though, if for some reason that stash of cash is inaccessible and it is needed sooner than later? What if there is a run on banks? What if there is a global computer virus that turns digital money in online savings accounts into a big fat zero? Lots of weird stuff can happen, especially in today’s unstable world.
Let me present another potential way to put together a rainy day fund. In my own personal plan, I have several layers of emergency funding. And just like Dave talks about, remember that an emergency fund is more in line with an insurance policy—not a way to do something “big” with money. Yes, piles of money will be lying around not growing as fast as they could be, and that’s okay.
Step 1: Purchase a Quality Safe
Depending on how many items need to be stored and how big the safe needs to be, costs for a good safe range from $200 to $1,000. I realize that may seem like a lot of money, but from personal experience, a safe is well worth the investment. Another personal note on safes: always go a little bigger than you think you need to. I bought my family’s current 1.2 cubic-foot safe around ten years ago. This size has been too small for our needs for the last four to five years. I recently added an extra safe about twice as large as the first, primarily to hold all the various Jones family legal documents. Be sure to buy a safe that is well built and has a high fire rating.
Step 2: Put $3,000-$5,000 in Your Safe
Depending on personal comfort level and “prepper” attitude, I would put anywhere between $3,000 to $5,000 cash in a safe. This is the first level of an emergency fund. And no, just like Dave talks about, this isn’t pizza money for dinner or a, “I need to go buy something on Craigslist right now” fund either. Pull together a decent-sized collection of $5s, $10s, and $20s for this first level of an emergency fund. In this way, if a bank account can’t be accessed in a crisis, there is cash at hand that will carry a family through a minor emergency for at least a few weeks.
Step 3: Place $2,000-$5,000 in a Savings Account at the Same Bank as Your Checking Account
Be sure you have both accounts linked together to move money back and forth as needed. This is your second level of an emergency fund. In this way, when you have a financial problem, you can immediately transfer the money you need from savings to checking to spend it immediately via check or debit card. This third step is most likely adequate for the majority of your “regular” emergencies such as car repairs, smaller home repairs, and minor medical emergencies. The next two steps will be the “icing on the cake” for your major, abnormal life emergencies.
Step 4: Save $10,000-$30,000 in a “Higher Yield” Savings Account
This account will be your largest savings account, closer to your three to six months of expenses. Place this money in a separate bank account that will take a few days to access the money. You don’t want to make it too easy to access. I recently found one of the highest percentage yield online accounts over at MySavingsDirect.com. At the time of this writing, it is 1.00% APR. There are many online banks like this. Check out this link at Nerd Wallet.
Step 5: Set-up Recurring Deposits to Your Savings Accounts to Fight Inflation
This next step is going to seem completely “geeky,” but to fight a yearly inflation rate of anywhere between 3 to 5 percent on your primary emergency fund in step four, I would take the high number of 5 percent and subtract the bank account interest gain of 1 percent, leaving you with 4 percent that you are “losing” out with your financial purchase power in your emergency savings due to inflation. Next, I would set up a small recurring deposit into this account to cover inflation losses. So, if a base emergency savings is $10,000, that amount times 5 percent inflation means a loss of around $500 per year. You are making 1 percent ($100) in interest and will need to cover the remaining $400 lost due to inflation. $400 divided by twelve months equals about $33 that would need to be deposited into the account each month. In this way, the three to six months of cash reserves will not lose its purchasing power in the event of a large emergency. Put this small deposit on autopilot between bank accounts. In the words of the great Ron Popeil, “set it and forget it!”
I have this “inflation busting” strategy set up with all our layers of emergency funding. Every month, I add $20 to our cash pile in our home safe (Step 2). I also have a small recurring transfer/deposit that automatically moves from our bank’s checking account over to our savings account (Step 3). All of our emergency money sources now keep pace with inflation.
Step 6: Max Out Your HSA Account
This final step is for those who have high deductible health insurance with an HSA account. Max this account out every year. In the year 2015 (you will need to check these numbers for the current year), a single person can contribute up to $3,350 per year. A family can contribute up to $6,650 per year. These amounts are 100 percent tax deductible (at least for now!) because they are withdrawn in pre-tax dollars. Medical emergencies are the number one reason people end up declaring bankruptcy. I would treat my HSA account as another layer of an emergency fund to protect my family against this bankruptcy statistic. Don’t be tempted after a good health year to cut back the amount deducted from each paycheck toward HSA the following year. Keep on plunking in the maximum amount and treat that HSA account as another layer of emergency funding in the area of health care. At some point it will be needed, so you may as well plan and prepare for a health care emergency.
This six-step approach is a more deliberate, organized plan than just sticking “three to six month’s worth of expense money in a money market account.” A good emergency plan prepares for the worst-case scenario occurring to the banking system. Because this is a debt-laden economy completely run by susceptible computer systems, trouble is inevitable if relying solely on the government and computers to be 100 percent reliable every day. Prepare for the worst and pray for the best!