While saving money for a rainy day may sound boring, not having the cash available for a true emergency is foolish, with a very small f. Sooner or later, it will rain.
A recent study by the Consumer Foundation of America found that only 40% of Americans have funds set aside for an emergency. And of that group, only slightly more than half had more than $2,000 set aside. Credit card issuers like Citigroup (NYSE:C) must salivate at those numbers.
What goes wrong
What derails most emergency savings plans is the temptation of loosely defining just what an emergency is. While a coffee addiction may cause a credit card crisis when the statement arrives, paying a credit card balance is not an emergency. Unexpected medical bills or automobile repairs, on the other hand, are emergencies and should be paid from an emergency fund.
That means that tapping an emergency fund to finance Christmas gifts, a summer vacation, or other foreseeable expenses should be off limits. If you're guilty of dipping into your emergency funds like this, consider using a separate bucket for Santa Claus or a trip to the beach.
Doing it right
Research from the Consumer Foundation of America also found that people who do have an emergency stash of cash make regular, systematic deposits, often via the Internet. One good option if you go that route is to use an online bank like ING (NYSE:ING) for your emergency funds. This forces you to open at least one more window before you get at your cash -- and many online banks offer higher interest rates than traditional banks do, often with no minimum balances or transaction fees, so you may not be as tempted to link your emergency fund to your checking account to cover overdrafts. If you do that, a spending spree at your favorite retailer can zap your emergency fund without you even realizing it. Modern technology does have its drawbacks.
That doesn't mean you have to go cold turkey with your spending. Treat yourself to a latte now and again -- just don't try to convince yourself that it's an emergency. Going through life without an emergency fund is working without a financial safety net. Have a little discipline in what really constitutes an emergency.
To learn more about where to put your short-term savings to work, check out our Savings Center. For help with personal financial issues try a 30 day no-obligation test-drive of our Motley Fool Green Light newsletter service.
Buz Livingston, CFP, loves good coffee but does not own shares of any of the companies mentioned in this article. His family's emergency fund is at ING Direct. He appreciates your feedback.
