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Your Personal Finance Seatbelt

August 20, 2010

Robert McNamara

Robert McNamara is most well know for his role as secretary of defense under Presidents Kennedy and Johnson during the Vietnam War.

McNamara studied economics at Berkeley, earned an MBA and taught at Harvard before World War II. He was a man of measurement and numbers and always used statistics to influence his decisions.

After World War II, he joined the Ford Motor Company, eventually becoming president. The rate of death from automobile accidents was high at the time:  in the 1950s, it was five times higher per mile driven than it is today.

So, McNamara and his team studied how they could make automobiles safer, which eventually led to the invention of seatbelts. Statistics show seatbelt use reduces the risk of death from accidents 70 percent.

It is easy to see in this case how an ounce of prevention is worth a pound of cure. The same is true with your personal finances. What are you doing in case of an emergency?

Some studies show 65 percent of Americans live paycheck to paycheck. This means when an emergency strikes — and we all have them — these Americans are forced to use credit cards and payday lenders to get by. Eventually the monthly car and house payments cannot be made. This really can destroy a person’s way of life.

An emergency fund should include three to six months of expenses. If you are in good shape with your finances and are secure in your job, three months of savings should be adequate. If you are nervous about losing your job, think you may have unexpected expenses coming up, have unique health situations, or face a variety of other factors that makes you less than completely confident, you should save six months of expenses in an emergency fund. There is no set formula for exactly how many months of expenses should be saved, but listen to your instincts and visit with your family to come up with a reasonable number for your situation.

The primary goal of your emergency fund is to protect your money. You do not what to bring more risk by trying to grow this savings. It also is important this money is liquid, meaning it is easy for you to get access to it. It usually is good to have this money saved in an FDIC institution so it is insured, even if the bank goes under.

A savings account is the primary tool used for emergency funds. This works really well for keeping the money safe and accessible, but the rates are about the worst you can find.

By opening up a money market account with a bank, you still can get the same security and access of the funds, but you earn a little higher rate. Most savings accounts currently are paying 0.1 to 0.5 percent interest. In our emergency fund, we get around 1.5 percent interest in a money market account in which we can write three checks against it for free every three months. One drawback is it usually takes a little more money to open a money market account than a checking account.

From a major household repair to an unforeseen medical condition to you or your spouse losing your job, you will have unexpected emergencies in your life.  Make sure you have your personal finance seatbelt:  the emergency fund.

On another note, I still am taking suggestions for your best wedding tips. E-mail me at andrewlong@fastmail.fm or go to https://greatwonder.wordpress.com to send me your tips. The person who has the best tip will win a copy of Dave Ramsey’s book “The Total Money Makeover.”

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