As a kid, many of us had parents who would recommend saving for a rainy day. That is good advice since rainy days will come and we don't know when. Financially speaking, every day is not sunny, where we have plenty of money to pay our bills and have money left over. In this economy, no one has a job that is rock solid secure. What do you do if your car breaks down and you need $750 to pay for repairs? If you don't have an emergency fund, many would pay for these repairs with a credit card. The problem with that is the interest charged by credit card companies, which can be as high as 25%. If an emergency fund is available, money can be used from that fund and you are charged zero interest. Therefore, the money needs to be liquid, meaning that we can have easy access to it with no penalties for withdrawals. Money that is tied up in stocks or a 401k or a certificate of deposit is not liquid. Cash in a safe or in a savings account is liquid. Emergency funds should be only used in emergencies, such as paying for medical bills, household repairs or car repairs. An emergency fund should not be used for a shopping spree at the mall or to pay for a vacation. Dave Ramsey recommends that $1000 is a good starting point for building an emergency fund. Over time it should grow bigger and bigger. Suze Orman recommends an emergency fund that is equal to eight months of a household's income. Emergency funds are important for households as well as businesses. I have heard about businesses that go under due to having a couple of months where the cash flow was less than normal. Businesses or households need to save when times are good, so that when money is tight, they have a reserve of cash. The key to financial fitness is being aware of the big picture, not just looking at making it day by day. Those who thrive are the ones who plan for the future. For example, contributing to a 401k with an employer match starting at age 25 versus age 35 can make a significant difference.
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