I’ve already touched on how to use high interest savings accounts to keep your emergency fund safe. I also mentioned that if you have debt, you need to establish a small emergency fund first and then worry about paying off your debt. As mentioned, your small emergency fund should be $1,000 if you make over $20,000 per year and $500 if you make less than $20,000 per year.

Once you have your baby emergency fund established and tucked away in a high interest savings account you need to get your debt snowball rolling. (I discussed the debt snowball solution here.) While some people have some criticisms of the debt snowball solution, it is still an effective way to start reducing your debt.

When you’ve used the debt snowball solution to reduce your high interest debt to zero, you can start to increase your emergency fund so that eventually it will be able to cover three to six months worth of expenses. I know having enough money to cover three to six months worth of expenses can seem like a daunting task, but it’s not. Here’s how to figure out how much money you’ll need to stash away in a high interest savings account.

Calculating a month’s worth of expenses

Here is how to calculate how much an emergency fund you’ll need:

The first thing you need to do is to look through your budget and bank account records and develop a list of all your monthly expenses. Once you have the list, cross off any non-essential items that you can go without. For example, cell phone plan extras like voicemail, caller ID or data plans. This new trimmed down list of monthly expenses is what you will use in the rest of your calculations.

Next you need to determine how many months worth of expenses you are going to tuck away. The minimum you should stash away inside a high interest savings account is three months worth of expenses and the most you would need to save is six months. The exact number of months you need to save depends on you and the type of job you have. For example, if you work in a volatile industry where there are regular layoffs you should save the maximum, six months. If, on the other hand, you live in a two income home or have a lot of job security you would only need to save three or four months worth of expenses. Other things to think about are the job market in your area and industry, security of your spouse has at their job or if there will be new financial commitments coming up.

Finally, this is the easy part, once you know your monthly expenses and how many months you want to store away, just multiply the two numbers. Personally, I work in a volatile industry and in a commission-based job so my aim is to save six months worth of expenses and my monthly expenses are $2,000. This means I need to save $12,000 to create an adequate emergency fund.

Revisit, review and revise

An emergency fund will cover you and your family when unavoidable tragedy strikes. To make sure that you are adequately covered, you need to:

• Revisit your emergency fund calculations every year
• Review your list of monthly expenses
• Revise your emergency fund where necessary. If you ever review your emergency fund and see that you have more saved than necessary, you should move it to a registered retirement account to shelter it from tax. But I’ll go into this in more detail at a later date.

As I mentioned in my previous post, high interest rate savings accounts are the best place to keep your emergency fund because it is a further step removed from the rest of your money. This means that when you have a moment of weakness, it will be harder to get at the money you have saved for emergencies.

Emergency funds, high interest savings accounts, debt reduction and life insurance are the very basics of personal finance. By making sure you reduce your debt, save enough and have proper insurance coverage you lay a healthy foundation for the rest of your financial life.

How do your determine how large your emergency fund should be? Are you comfortable will how much you have saved? Let me know what you think, comment below.

I have decided to start this blog with a series of posts that deal with the basics of personal finance. This is the first post in this series. To make sure you catch the rest of the series and future posts subscribe to our feed and follow Savings Chronicle on Twitter.

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High interest savings accounts are the best place for people to keep their emergency funds. Better still; pick from the best internet savings accounts available, such as the Orange Savings Account from ING Direct.

Internet savings accounts are the best place to park your emergency fund because it keeps you funds beyond arms reach. In other words, having your emergency fund in one of the many high interest savings accounts available means that there will be a few more steps involved to tap into the funds you have set aside. This will shelter your emergency fund from any weak-willed moments you may suffer.

Why are emergency funds so important? They are important because when people don’t have emergency funds in place, they fall back on credit and fall into debt when an emergency happens. Recent data released in the media is a prime example of this.

The need

New information was released last week that showed the number of Canadian’s defaulting on credit card payments is increasing. The number of credit card accounts that are more than 30 days past due sits at 2.82 per cent, an almost 25 per cent increase from this time last year. The reason behind the increasing rate of credit card default is that credit card balances are ballooning.

Credit card balances are ballooning because people are losing their jobs and losing income. To replace the lost income and pay the bills people are falling back on credit. With increased balances come increased minimum payments and eventually they get to the point where people can no longer make the payment. When it comes to the point where people can no longer make their monthly payments a bad situation becomes much worse.

When you default on a credit card account you are penalized in two ways. First, your credit rating suffers and it will be harder to get a mortgage, line of credit or a car loan in the future. Second, the credit card company may slam you with increased interest rates and extra fees for being late with a payment.

The sad thing is that situations like these are increasing and the financial health of more people is suffering. It is even more tragic when we realize it can easily be avoided. It can be avoided by setting up an emergency fund when times are good.

An emergency fund is when you set aside extra cash in a safe place to pay for the unexpected, but unavoidable, things life throws at you. Murphy was right: eventually whatever can go wrong, will go wrong. Since these emergency situations are assured you need to have something other than credit to fall back on when they happen. Here is how to set up your own emergency fund.

How much?

How much you put aside for emergencies depends on if you have high interest credit card debt sitting around. If you do, then you need to set up a temporary emergency fund while you pay off your debt. This baby emergency fund should be $1,000 or $500 if you make less than $20,000 per year.

If you are out of debt it’s time for your small emergency fund to grow up. A full-blown emergency fund should be large enough to cover three to six months worth of expenses. I say three to six months because the actual amount will depend on you. If you have a job in a volatile market and you only have one income coming in then you should have a six month cushion. If you live in a dual income household then you may be able to get by with a smaller emergency fund.

Where you should keep it

Like I mentioned in the introduction above, you need to keep your emergency fund in one of the high interest rate savings accounts available. Your current bank probably has a high interest rate savings account, but the fees with these are typically rather high and require that you maintain a minimum balance. These fees and restrictions can make it expensive to keep a savings account at your everyday bank. If you are comfortable with online banking there are other and less expensive options available to you.

At the time of writing this some of the best internet savings accounts with the highest savings account interest rates are:

• Ally Bank 1.75%
• People’s Trust 2.10%
• Maxa Financial 2.00%
• Canadian Tire Bank 1.20%
• Outlook Financial 1.50%
• ING Direct Orange Savings Account 1.30%

You can set up an account and make regular monthly deposits at any of these banks. Once you have your emergency fund established you won’t have to worry about going into default and relying on credit when the unexpected happens.

I have decided to start this blog with a series of posts that deal with the basics of personal finance. This is the first post in this series. To make sure you catch the rest of the series and future posts subscribe to our feed and follow Savings Chronicle on Twitter.

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