That is an excellent question! As a financial planner I usually advise my clients to save as long as their personal financial situation permits it. As a person who has the worst luck in the entire world I also personally like to have savings set aside in case of an “emergency”. Over the past two years my personal “emergencies” (which always involves my car) have cost me over $3000. Therefore I was happy to be able to pay cash and not rack up the bills on my credit card.
However, saving is not always for everyone. If you have debt it doesn’t really make a lot of sense to save because you may be paying 19% interest on your credit card, and you may only be earning 1% in interest on your savings account. I am not saying that you should not have emergency funds; I am just saying that the priority should be paying off debt. I stick by this point because interest over the long term will cost you a lot more than your emergency fund. If you do have a balance on your credit card don’t use your emergency funds to pay it off, just stop contributing to your emergency fund until the debts are paid off.
If the idea of having no emergency funds scares you, and you would like to continue contributing to your savings, then you should adjust your savings to also include paying off your debt. Your savings should always be in your personal budget. If your budget allocation for savings is 5% of your salary then lower it to 2% and allocate the other 3% to paying off debts. It is easier if you make a budget plan that corresponds with your pay checks. If you are paid weekly then make a weekly budget, if you are paid on a biweekly basis then make a biweekly budget.
Emergency Funds should always be invested in a liquid type of cash investment that you can access within 24 hours…just in case. Savings for a specific goal and/or savings for retirement are completely aside from saving for emergency funds. Liquid cashable investments include t-bills, money market, cashable term deposits, and high interest savings accounts. You may not have access to these accounts with your ATM card but you will have access by contacting your personal banker.
High interest savings accounts are very popular these days among both banks and consumers. A new product that has also been introduced in other countries such as Canada and the European Union is the Tax Free Savings Account. This is an account that allows investors to invest up to a predetermined amount each year completely tax free. There is no tax paid on interest, dividends, and capital gains earned while the money is invested inside the account. There is also no tax paid on any withdrawals from the account. Of course there are age and residency restrictions regarding who can open the Tax Free Savings Account.
It is always a good idea to have some savings set aside for unseen personal emergencies. The amount of savings that an investor “should” have varies depending on who you ask. Some investment advisors say to set aside 5% of your annual income. Others say to set aside the equivalent of 3 months net salary. I say ideally 5-10% of your annual salary should be set aside. This is a fixed amount; I don’t suggest you continuously set it aside each year. As an example if you earn $100,000 a year before tax, you should have between $5000 and $10,000 in cash savings for emergencies. However, the percentage that you are able to save always depends on your monthly expenses and personal budget. Finances are a personal decision and are based on individual circumstances.
(photo by xJasonRogersx)