In the hideous biweekly pay environment, no matter how you try to arrange things there will be times when you will find yourself without enough to cover your normal bills. This happens because paydays move around, so that occasionally your second paycheck of the month arrives after your bills are due and after other living expenses have consumed most of your first paycheck.
That’s the case for me this month: automatic payments for all my utilities and two insurance bills are made by the 20th. My Visa bill will be due about then, too (fortunately, it will be small). Normally plenty of money is in the account to cover all these expenses, because normally by the 20th two paychecks have been fed into that account. The first paycheck covers my recurring expenses and a few other living expenses; the second covers the rest of the grocery bills and such costs. But not this month: in April I don’t get paid until the 25th.
On April 20, when the American Express billing cycle closes, I will be $200 in the hole.
The credit union, however, will think I have $300 left in my checking account. The only reason the account will appear to be in the black even after I’ve spent $200 more than I deposited it is that I keep a $500 cushion in that account. I make it a matter of principle never to go below that $500 cushion. So, in my universe a balance of $500 is the same as zero, and a balance of $300 means the account is really $200 in the red.
The only thing between me and two hundred bucks’ worth of bounced transactions is an emergency fund of a few hundred dollars.
As we have seen, I have about $18,000 in an emergency fund, enough to tide me over for six months should I lose my job. Since I started setting money aside in a fund to pay off the low-interest Renovation Loan, I’ve managed to squirrel away another $13,000, which if push came to shove could serve as more emergency cash. Most of this money is kept in conservative mutual funds, where it earns a little interest.
However, I keep $500 of it in my checking account for exactly the kind of short-term emergency I’m experiencing this month.
The April 25 paycheck will replenish the checking account’s emergency cushion and cover the rest of my April bills. But May also will see the second paycheck come in after all my recurring bills are due, and so once again I will need that $500 cushion to keep from overdrawing the account.
A back-up for the checking-account cushion is check-bouncing protection, a line of credit extended by the credit union which, for a fee, will cover overdrafts up to $3,000, about one month’s net pay. As long as no payments are drawn on this line of credit, it costs me nothing. If I bounce a check or EFT, the interest will be around 11%, but if I repay the overdraft immediately, it will cost me just a few dollars—a far cry from a bounced-check penalty and the umbrage of creditors.
So, here’s a sensible approach to managing emergency funds as they accrue:
1. First, build a cushion in your checking account that will cover a short-term overdraft.
Consider this amount to be your “zero” point! When your balance approaches the amount of your cushion, regard it as actually approaching zero. When you start to eat into your cushion, your checking account is in the negative numbers. Behave accordingly: quit spending and find a way to replenish the checking account as fast as you can, even if it means transferring funds from savings.
2. Once the checking-account cushion is in place, continue building your emergency fund, but plan to invest the bulk of the money in an interest-bearing account. When you reach $3,000, for example, you can open a low-expense fund at Vanguard, where a money market fund pays as much as the highest-paying bank savings accounts do and where other relatively safe instruments return around 8% over time.
3. Get overdraft protection with your bank or credit union. If your bank charges you for this service, move your accounts to a bank that restrains itself from gouging you.
Overdraft protection is your emergency fund’s emergency fund. In the event of a minor disaster-a late paycheck, for example-it gives you an extra safety net. Arrange for this while you still have a job, because of course if you are unemployed you’re unlikely to qualify for a line of credit.
categories: personal finance
2 Comments from iWeb site
Good advice!I certainly sleep better at night with a small emergency fun, even while I’m paying off my credit card debt.
Tuesday, April 8, 2008 – 08:19 AM
When in college, I had $200 which I considered untouchable. And my account never went below that…but if something had come up, it could have. I also had savings linked to my checking, which helped just in case.
Tuesday, April 8, 2008 – 09:56 AM