Everyone knows they need to save money. It is the most obvious financial necessity, yet the one most people look past. According to a Bankrate financial literacy survey, 66 percent of respondents recognized it was very important to keep three months' worth of living expenses saved, while another 26 percent said it was somewhat important. However, only 44 percent said they actually keep this amount of savings on hand at all times, while 28 percent said they sometimes do.
A recent poll by USA Today revealed the most important financial goal in 2005 is to pay off debt (29 percent), ahead of saving more for retirement (24 percent), saving more for large purchases (18 percent), estate planning (6 percent) and life insurance (3 percent). Meanwhile, debt continues to rise. In fact, according to Cardweb.com, the average credit card debt per household in the United States is $9,205. To make matters worse, interest rates and credit card fees are on the rise. Specifically, the average late fee was $32.49 in 2004, up from $31.24 in 2003. These fees can add up quickly. In fact, Americans paid more than $24 billion in credit card fees in 2004 -- $14.8 billion in penalty fees, $6.1 billion in cash advance fees and $3.5 billion in annual fees -- an 18 percent increase from 2003.
What Do You Need?
Not only is it important to have money saved in case of a major financial crisis such as an unexpected job loss, illness or accident, but it is also important to have a short-term emergency fund to handle minor financial emergencies, such as a car repair or new appliance. For example, on average, it costs between $7,000 and $10,000 to replace a roof and $300 to repair a washer and dryer. As such, when thinking about your savings, you should think in terms of long-term and short-term needs.
Long-term: You should have three to six months of your current living expenses socked away in an emergency fund. To determine how much you will need, take into account all of your monthly bills, including: mortgage or rent; car loans; gasoline; credit card bills; utilities; food; medical costs not covered by insurance and/or the cost of COBRA; day care; etc.
Short-term: Although most minor emergencies usually cost less than $1,000, you need to evaluate your personal situation to determine how much you should have on hand. For example, take into account your family situation, the age of your appliances and car, as well as other items in your household that might need repair or replacement.
1. Do it for your kids
Money is a major cause of stress for all, but can be a particularly damaging concern for children. According to a survey by the National Center on Addiction and Substance Abuse at Columbia University, high-stress teens are twice as likely as low-stress teens to smoke, drink and use illegal drugs.
While the results of stress may not always be as dire as those revealed in Columbia's study, children learn money habits from their parents. As such, it is important to set an example when it comes to spending and saving money -- one which you want your children to follow.
2. Slow and steady
Think of saving as you would any long-term goal. For example, a new runner would not set out to run a marathon, but would first train for shorter distances like one mile, three miles and even a half marathon. This is the same approach you should keep in mind with your savings goals -- slow and steady. Keep in mind -- you are not necessarily starting at zero. In fact, the change in your dresser drawer can be an excellent place to start. According to Coinstar, a company with automated change collection machines, more than 80 percent of American homes keep a coin jar or other container with stored-up change. Their latest figures indicate that $10.5 billion in change (including pennies) is sitting idle in American homes -- that represents approximately $99 per household.
After cashing in this spare change, make a commitment to save $5 a day for the next three months. Three months later, commit to saving $10 a day for the subsequent three months. After those months pass, increase your commitment to $15 a day every month for three months and finally $20 a day for the final months. After one year, you will have saved $4,500 for emergency needs and you will have created a long-term savings strategy that will benefit you for the rest of your life.
3. Save like you are paying a bill
As you approach this idea of a daily and monthly savings goal, it is important to get a handle on where your income is going each month. Once you calculate how much you can save each month, add this amount to your monthly "expense list" (i.e., think of it as you would any other bill). To ensure you remain committed to paying this "bill" each month, you may want to consider having the money automatically deducted from your checking account and deposited into a savings vehicle, such as a money market account. When trying to build an emergency savings account, do not be tempted to remove money from your 401(k) plan or reduce your contributions. It is important to ensure your budget contains room for both types of savings.
4. Save a portion of your tax refund
According to the Internal Revenue Service, the average tax refund last year was $2,063. This year, make a commitment to save one-quarter of your refund for your emergency savings account. Assuming the national refund is around $2,000 that could mean $500 extra for your savings.
5. Avoid ATM fees and other frivolous purchases
How many times do you use an ATM not belonging to your bank? If you are like most consumers, the answer is too often. With the average surcharge levied around $3 ($1.47 from the other bank and $1.50 from your own) this is a sure way to cut into your savings. Assuming you visit an ATM outside of your bank's network once a week, you are looking at $144 you could have put toward your emergency savings account.
Additionally, make a commitment to not buy a single item of clothing unless it is on sale. This is another easy way to avoid unnecessary purchases and to save some additional money.
6. Avoid the mattress
The ideal investment vehicle for your emergency fund is one which is safe, liquid and easily accessible. Avoid stashing your savings in your mattress, closet or drawer as your money is not only at risk of being misplaced or stolen, but a bedspring, pile of clothes or pair of socks are the only things keeping you from skimming the fund. Additionally, you want to avoid putting your money in an account with ATM access or check writing privileges. As such, the best choice is a money market fund:
Money market fund: A money market fund is an investment vehicle offered by a brokerage firm or mutual fund company. The money invested in such a fund is invested in highly liquid, safe investment options like U.S. Treasury bonds. The investment return in a money market fund is slightly higher than a bank's money market account, but the money invested is not insured. Despite the lack of FDIC backing, this is my preferred vehicle for an emergency savings account because you cannot access your account through an ATM. However, it is important to invest in a money market fund with a proven track record. You want to avoid money market funds that advertise their "high" rates of return as this is one fund account where you absolutely do not want your money to be at risk.
Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is "Good Morning America's" personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.