What can $1,000 do? In a world where the average family has more than $8,000 in credit card debt, $1,000 doesn’t seem like much. Don’t get me wrong, it is still a lot of money but $1,000 just doesn’t go very far these days.
Why is our first recommendation when beginning a Total Money Makeover to save $1,000? Why not pay off some debt instead? That is the point, isn’t it? In a way, having a small pile of cash in a simple savings account (or even in your sock drawer) is a form of insurance. Yes, I said insurance. Think of it this way:
Option A: You decide to get out of debt. You have $1,000 in your pocket and decide to pay off a $200 medical bill and put the rest towards paying extra on your credit card debt. You mail an $800 check to the credit card company and on the way home from paying the $200 bill at the doctor’s office you get a flat tire. What is your next step? You might be taking a BUNCH of steps – to and from work since you no longer borrow money, no longer use credit cards, and don’t have $150 to replace the tire.
Option B: You decide to get out of debt and have $1,000 in your pocket. You don’t send any to the doctor or credit card this payday but put the $1,000 in a simple savings account at the bank. On the way home you get a flat tire. Your next step? Replace the flat tire with $150 from the savings account and continue on with your life. The credit card and doctor can wait 2 more weeks until your next paycheck, right now you have to go to work to earn some money.
You will continue to work and pay down debt from your next paycheck. It’s OK. Payday isn’t that far off. In two weeks you will take $150 from your paycheck and put it in the savings account, bringing the emergency fund back up to $1,000, and any extra money will be put towards paying off those debts.
So we can say that “Baby Step 1 – $1,000 baby emergency fund” is like insurance. In this example you held off paying down on debt for 2 weeks and stayed on track. That’s better than your previous plan of incurring more debts and/or maintaining a balance on credit.
The cushion of having a little bit of money in cash will help even-out some of the bumps in your road to financial freedom!