Think back to elementary school, can you remember how many times your school had a fire drill? They were never announced ahead of time, the bells just rang, everyone got up, lined up, and left the building in an orderly fashion. Everyone knew what they were supposed to do because it was scripted ahead of time. No one panicked because we always assumed it was a drill, even when it wasn’t. (which puzzles me why all of my employers pre-announced rare fire drills)

When was the last time you had a financial fire? Maybe the car broke down or you broke a window in your house. Maybe you were one of the many millions who lost your job last year. I bet, in most cases, you weren’t sure what to do afterwards.

That’s why I’m recommending that you conduct a financial fire drill.

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We put our emergency fund into a CD ladder and every month one of those certificates of deposit matures and is automatically renewed. As an added bonus, ING Direct, where our CDs live, gives us a CD rollover bonus whenever we renew (currently the bonus is 0.15% on CDs of at least 12-months long). For us, the decision is simple. It’s a CD ladder and you simply renew the CD each month for the 12 month term.

What if you’re money isn’t in a CD because it’s part of a CD ladder, what should you do?

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Rules of thumb are great. They teach you a little nugget of wisdom and have been vetted by generations of experience. Don’t swim thirty minutes after eating, don’t mix hard liquor and beer, and don’t date your relatives. Follow those rules of thumb and you’ll live a happy and healthy life.

The same can be said about financial rules of thumb. Don’t spend more than you earn, save 10% of your salary, and always buy a used car. You don’t have to always follow those rules of thumb, but if you want to achieve financial prosperity, it’s best to heed them.

However, over the years, some rules of thumb are in need of a refresher. Times change. A rule that made sense ten or twenty, or even a hundred, years ago may not make sense. Let’s have a look.

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This article is part of the series, The Summer of George- The Most Productive Summer a College Student Will Ever Have.

Do you think that you don’t earn enough money have to worry about managing your finances? If so you are dead wrong. If you get into the habit of properly managing your finances at an early age then these habits will hopefully follow you into your 30s and so on. Let this summer be known as the time where you finally took control of your financial situation.

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There are so many sites that are happy to give you strategies to get the most out of your emergency fund or how to best save for your emergency fund, but the simplest and quickest way to give yourself a cushion is revealed in this minute and a half video. (I must confess, it was on my mind because it was the topic of episode #2 of the Personal Finance Hour)

Over three million, six hundred thousand jobs have been lost since the recession started over a year ago. Three million, six hundred thousand. If you’re one of the three million, six hundred thousand, my heart goes out to you and I hope you’ll follow my friend Sarah as she chronicles her battle against joblessness in Diary of a Firee. If you still have your job and you haven’t started preparing for the possibility that you will lose it, start preparing. You have all the tools you need right now to fortify your finances so that, should you lose your job, you will be prepared for it.

These tips were tailored for young professionals but they can apply to anyone. They are focused less on family-related money saving ideas and more on the things individuals and couples tend to do, especially if they’re in the younger working demographic.

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It’s seven o’clock and you’re just leaving work. You’re tired after a long day of work and all you want to do is turn into a vegetable in front of yet another episode of Law and Order. As you walk to your car, you notice someone clipped the bumper and managed to unhinge it from the chassis. It’s scraped, a little cracked, and almost most importantly, since it is the bumped, it looks like crap. The culprit left no note. You are probably out a few hundred dollars of your deductible to get it repaired… fortunately you have an emergency fund… unfortunately, you’ll have to tap into it for this.

That situation is one of any number of reasons why emergency funds are so important. In the situation above, you are likely required by law to fix an unhinged bumper and any visit to the shop will cost you a few hundred bucks. Without an emergency fund, you might resort to a credit card or a short term loan. If you can’t pay that back, it quickly becomes a downward spiral you can’t escape. A minor expense becomes a major expense. But how much should you have saved in an emergency fund? The answer depends on who you ask! Some experts say twelve months of expenses, other will say six months, and even others say “however much you feel comfortable with.” The answer, unfortunately, is that the amount “depends” on you and your situation.

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I quit investing in the stock market.

OK, just kidding, I didn’t really quit. I haven’t changed my retirement contributions in anyway (though I feel foolish every time I see a contribution go through, followed by the stock market falling even further). I left my retirement contributions alone because my time horizon gives me the the benefit of time, the one certain cure for this economic malaise.

However, we have stopped contributing to our taxable brokerage accounts simply because of how violent the market has become. Check out the CBOE volatility indices:

• VIX – S&P 500 Volatility Index
• VXN – Nasdaq 100 Volatility Index
• VXD – DJIA Volatility Index

The volatility indices show the market’s expectation for volatility over the next thirty days and as you can see on their charts, they’re at all time highs. That’s why we’re not putting in any more money, we are going to wait until things calm down before we add back in. (That account was for savings on items we need beyond the next five years)

So, without the stock market, the next question is where should we go with our savings?

Bolster The Emergency Fund

This is never a bad decision. With the economy the way it is, we should use any abundance we have left to start saving for potentially leaner months (or years) to come. If you listen to any experts, you might notice more and more are bolstering up their cash positions. As regular people, emergency funds (and CDs/High Yield Savings) are our cash positions and it’s never a bad idea to squirrel away a few nuts for the winter.

Pay Down Debt

If you have any debt, whether it’s a 6% mortgage or a 20% credit card, paying it down is a smart move. Some would say that you should invest your money and take advantage of the leverage, but I think that’s a little too risky given the volatility of the market. The rewards you will reap by getting rid of your debt will far outweigh the potential gains you’ll earn in our current market. I’m not saying that the money you put into the market will be lost, maybe we have hit the bottom and its on its way up, but by paying down debt you free yourself in a way a few extra dollars in stock gains simply won’t. Also, when you pay down a debt, that rate of return is guaranteed.

CDs & High Yield Savings Accounts

There’s nothing wrong with taking the 3-5% APY of a certificate of deposit (the best cd rates are hitting 5% APY) or a high yield savings account (the best high yield savings account rates are near 4% APY). I think there is a stigma against taking these “safe” gains because we have it in our heads that the stock market can yield returns of 10%. The reality is that the 10% metric is one that’s been overplayed and so ingrained that people are looking at the volatility in the market today and wondering how that figure could possible be correct. It’s not. The market may have yielded gains of 10% since the beginning of time but as all mutual funds state – “past returns are not indicative of future performance.”

One thing is certain though – a certificate of deposit or high yield savings account will get you that yield. The worst case is that you get your money back (bank failure). Unlike money market accounts, CDs and savings accounts are FDIC insured and you’re protected from loss.

Take the safe bet, it’s OK!

Invest In Yourself

Now is the perfect time to invest in yourself by taking some classes, buying some books, and otherwise augmenting your skills to make yourself a more attractive employee or prospective employee. Investing in yourself is one of the best things you can do with your money as knowledge is something that can stay with you for a very long time and there’s always something you can learn.

You don’t have to go as far as taking a class but if you’re in an industry where certifications, and the knowledge those certifications confirm, are important, go out and test for them. In certification heavy fields, many requisitions are filled by those certificates.

Invest In Money-Savers

It’s often said that replacing a ten year old refrigerator can yield significant cost savings (some figures claim $100-$200 of savings [1] [2]). If you have a ten year old refrigerator, consider taking your investment money and replacing it. Let’s say you buy a $2000 fridge and it saves you $100 a year in energy costs – that’s a 5% return on your investment. Since that 5% isn’t taxed, that’s the same as a 6.67% return in the stock market if you’re in the 25% marginal tax bracket. 6.67% return, a new fridge, and being nicer to the environment isn’t too shabby, is it?

There are plenty of other money-savers you can find both in and outside of your home.

Do you have any suggestions on where people can invest nowadays?

(Photo: thewalkingirony)

This is the first of a series of seven posts titled the 7 Deadly Sins of Personal Finance. In the next week, I’ll discuss seven mistakes I think we must avoid if we’re going to be successful managing our money. They’re things I’ve learned the last few years as both a personal finance blogger and manager of my own money in our ever changing world. Hopefully you can both take something away from these and give me your own take on the points I bring up.

Without further ado, the first deadly sin of personal finance is…

Not Having An Emergency Fund

An emergency fund is a fund that you set aside specifically to handle the unforeseen emergencies in your life. Some save as little as three months of expenses, others save as many as a year’s worth of expenses, we are going with six months plus adjustments for extenuating or mitigating circumstances. Currently our emergency fund is at six months with no adjustments because we have two incomes and that mitigates the risks brought on by a slowing economy. If we were single income, I might adjust that upward to seven or eight months. If we had kids, I’d adjust it to a full twelve. It’s better to be safe than sorry, you won’t lose much, especially in this economy, by having too much in your emergency fund.

Why is an emergency fund important? When you have a pot of money set aside for emergencies, you don’t need to rely on loans or credits to pay for the emergency. A prime example is a simple flat tire in your car. A flat tire can happen any day and, while not catastrophic, can cost you anywhere from a hundred to two hundred dollars. If you have an emergency fund, you can pay for the service without worrying about adding to your existing debt. With an emergency fund backing you up, you don’t have ride on your donut spare tire (very dangerous!) until your next paycheck.

A flat tire is easy, what about something bigger? Sticking with the car theme, let’s say a rock cracks your windshield when you’re driving to work. Windshield replacement is a little more expensive. With an emergency fund, you can quickly pay for a repair or replacement that can prevent further emergencies down the road. Driving with a cracked windshield is extremely dangerous and with an emergency fund you can take care of those problems quickly and before they develop into bigger problems.

How should you save? This is the easy part. The first step is to budget and figure out how much your monthly expenses are. If you don’t have any empirical data, here’s what I’d do. First, get a ballpark estimate of expenses by calculating what 75% of your pre-tax income is. Use that as your expenses numbers for the first month while you collect data, then replace it with the actuals once you have them.

The best place to save is to open a high yield savings account at an online bank and set up an automatic transfers each month from your checking account. Don’t put it in the stock market, don’t put it in any other investments, and don’t leave it in your checking account where it won’t accrue interest.

That’s it! And like that, you have an emergency fund. If you didn’t have one before and you’re now worried your fund is small, don’t worry. You have a plan in place now and it’s just a matter of time before the savings accumulate. In the event that you do experience an emergency before the fund can handle it, you’re no worse off now than you were before you started the fund. Handle it as you would’ve but keep following the plan.

One last bit of advice: Don’t spend that fund unless it’s on a true emergency. I’ve heard of stories where people have stumbled on a “great investment tip” and raid that fund (you should set up an opportunity fund for that). Don’t. The purpose of that fund is to make sure you don’t fall down a deep deep hole because of one simple financially focused event.

Thoughts?

The New York Times recently released a great series about consumer debt called The Debt Trap. One common thread in several of the videos is the devastating effect “emergencies” can have on your personal finances. A medical emergency, a job loss or cutback in hours, all of these emergencies were weathered, in the short term, with credit cards. In the long term, the credit cards charged high interest rates, piled on fees, and made it extremely difficult to recover. It’s like telling someone to pause for five minutes in the middle of a foot race so that you can strap on a 100 pound rucksack. You might catch up, but probably not.

This underscores the incredible importance of having an emergency fund. The economic climate is pretty rough right now. IndyMac went into conservatorship, Wachovia announced they were slashing 11,000 jobs, and the price of oil gyrates in the triple digits. The stock market is down and there’s a lot of red in those brokerage accounts. The last thing on most people’s minds is boosting that emergency fund. But now is the most important time to focus on your emergency fund.

In times of prosperity, it’s easier to weather emergencies without a plan. Bonuses are bigger, regular and OT hours are more plentiful, and there is less fear that you’ll lose your job. Boosting an emergency fund isn’t fun, but neither is crushing debt, bankruptcy, eviction, and the unfortunate feelings that come with it.

Feel your job is 100% safe? That’s great, but that’s actually not the most devastating emergency. About about half of all bankruptcies are the result of medical bills. You can’t predict the future, but you can prepare for it.

How To Start a Fund?

It’s very simple, get your check book, get your budget, and open an account at FNBO Direct (FNBO Direct review, or pick any one of these high yield savings accounts), they are currently paying 3.50% APY. If online banks make you uncomfortable, open one at your local bank. A fund at 0% APY is better than no fund at all.

You’ll want to save at least six months of expenses, which you can tell from your budget (you budget right???). Try to accumulate that over [insert comfortable time period here]. The faster you do it, by sacrificing some discretionary spending now, the better.

Another option is to ladder your emergency fund in certificates of deposit. One place that makes it very easy is ING Direct but their current rates are all in the 3.30% APY to 3.00% APY range, less than HSBC Direct’s standard high yield savings account rate, so I would put it in HSBC Direct for now.

What are you waiting for?

(Photo: c.violette.run)