Free Money Finance

How is Your Emergency Fund Doing?

The Wall Street Journal discussed emergency funds recently and noted the following:

The oft-quoted rule of thumb is to save three to six months of living expenses in your emergency fund. But many people these days will need nine months to a year of expenses covered just to get by. Consider that the average duration of unemployment is nearly 40 weeks. That means even if you have six months of expenses saved, there's a good chance you'll use it up before landing a new job.

They also quote these startling facts:

According to a 2011 study by Bankrate.com, 46% of Americans haven't saved enough to cover three months of expenses. And only 24% have saved enough to cover six months or more.

Yikes!

And just to show how bad things really are, the post features a chart where people are asked if their credit card debt is greater than the size of their emergency fund. The results:

• 54% said no, their credit card debt wasn't greater than their emergency fund savings


• 25% said yes, their credit card debt was greater than their emergency fund savings


• 16% said they didn't have credit card debt or emergency fund savings


• 5% didn't know or didn't answer

Several comments from me:

• I don't hold to a set level of emergency funds for everyone, but six months is a good general guideline for someone looking for basic guidance. If you want to get more specific, the post Six Levels of Emergency Funds. gives some additional details.


• Personally we have about six months of salary saved up which equates to 12 months or so (probably more) of living expenses. It may be a little overkill for us, so I might trim it back a bit.


• Looks like only 24% of the people have met the six-month guideline. Said in reverse, 76% of the people don't have enough stocked away in their emergency funds (especially those 46% who have less than three months of expenses saved).


• Then there's the 25% of people who have more credit card debt than emergency fund savings. These people are living on top of financial time bombs. At least the 16% who have neither are in better shape than this group because they aren't paying outrageous interest charges on their credit card balances.


• I wonder how much of these poor results come from the bad economy. Or would we have seen similar numbers prior to 2008? It's hard to tell, but my guess is that it's a combination of both -- there's a group of people that won't have emergency funds no matter what and there's another group that has had to deplete (or at least lessen) their emergency funds because this economy has caused them to face an emergency (like a job loss.)

How about you? What's your current emergency fund status?

Are Accrued Vacation Days a Form of an Emergency Fund?

For the past few years I have not used all of my vacation days. My company's policy is that I can roll these days over to the next year (unlimited), get paid for them, or any combination of rolling over and being paid. I've always rolled them over for a couple reasons:

• I have been planning on taking an extended vacation. I'll be using 16 days or so this year during my cruise to the Caribbean.


• IMO, having vacation accumulated is a form of an emergency fund.

My thinking on the second point is that we all have (or are supposed to have) X months' of living expenses saved in case something happens to our employment situation, right? Let's say it's six months (though I've posted that actual needs could be higher or lower than this based on your specific situation.) So you can literally have six months' of expenses saved OR you can have five months' of expenses saved plus one month of vacation days, right? Either way, you're covered for six months.

Is this a correct way of thinking of this or am I off my rocker? And does anyone really care or is it just me who thinks of these mundane personal finance topics? ;-)

The Need to Save Money is Life or Death

The following is excerpted with permission of the publisher John Wiley & Sons, Inc. from What Would Ben Stein Do: Applying the Wisdom of a Modern-Day Prophet to Tackle the Challenges of Work and Life by Ben Stein. Copyright (c) 2011 by Ben Stein. 

I keep saying it––and it's true. We writers and actors and economists do not live off on a desert island. We live in the world. We interact with other people. Sometimes these other people tell us heartrending tales.

For many years while I was doing Win Ben Stein's Money,  I had as a colleague a woman now approaching middle age as a member of our production crew. She was and is a highly capable, pleasant woman, whose work product was spectacularly fine.

After Win Ben Stein's Money ended, she got a far better job on a much bigger show and worked on it successfully for eight jolly years. Again, her work product was well liked.

Then, with zero warning, she was fired for absolutely no cause in early 2011. WHAM! Right out of the blue. She was given six weeks’ worth of severance pay and asked to leave.

She was extremely dismayed. Terrified might be a better way to put it. She had savings equal to about three months’ expenditures. Hollywood production jobs are notoriously hard to get. Even someone as talented as she is would have trouble getting the kind of steady work she had on her most recent eight-year run.

The situation gets worse. She has an enormous dog. For the enjoyment of the dog, she bought a home she could barely afford even when fully employed. Now, facing possibly prolonged unemployment, she couldn't possibly afford the home. She considered downsizing to a rental, but it was difficult finding one that accepted pets. She loved that dog the way parents love their children. So she was literally left with no clue for what to do.

So here's the lesson. While my friend fell into some bad luck, the reality is that there is a country in which about half of the working families have savings of less than two months’ expenditures, and never imagine that they might lose their source of income. That country is called the United States of America. This is a country of wonderfully kind and pleasant human beings. I marvel at how sunny they are as I crisscross the nation on my endless travels. But it is a country of many wildly imprudent, slobby people where money is concerned.

This is a country where, as a matter of course, men and women use the last of their savings to buy big-screen TVs or boats or trips to Buenos Aires, always in the magical thinking delusion that things will somehow work out right in the end––just as they do in movies.

The problem is that life is not the movies. Things very often do not work out right. This problem of things turning out badly is especially cruel when it comes to money. So much of this country is exposed to likely bad outcomes where money is concerned that it approaches crisis levels.

It is so important that you not let yourself be included in this vulnerable, exposed group, that it's impossible to overstate the seriousness of the matter. YOU MUST HAVE SAVINGS.

Maybe you don't need them if you are a Rockefeller and you are under 16 years old. But everyone else needs them.

Financial Strategy #6: Savings Over Debt

The book Your Stronger Financial Future: The Eight Essential Strategies for Making Profitable Investments lists eight misconceptions, truths, and strategies to help readers deal with a variety of major financial issues. I'll be highlighting these in several posts and giving you my thoughts on them.

Today we'll look at strategy #6 which deals with accumulating savings over accruing debt. The book says the following on this subject:

• The misconception: Leverage is the key to prosperity.


• The truth: Leverage is debt -- and is almost always a bad idea.


• The strategy: Rather than accruing debt, accumulate savings.

They go on to say that there are three instances where debt is tolerable:

• A mortgage on a house, especially if the note is a maximum of seven years.


• A car loan for two years or less.


• A student loan, where your expected future compensation is clearly able to repay the debt quickly.

The book hates credit card debt and suggests that you should start saving 10% of your income.

Here's my take on all of this:

• I agree that a mortgage can be much shorter than 30 years and even 15 years can be beaten fairly easily. How? By using my formula for buying a home. It's how we paid of our mortgage early.


• Personally, I don't like car loans at all. I'd give someone the grace for a two-year one while they were working up to save completely for the next one, but I'd only offer a one-time exception per person. (FYI, if there was a 0% deal, I'd be ok with taking that loan -- as long as you negotiate the best price you can before you talk loans. In other words, I wouldn't pay more for the car to get the 0% deal.)


• Got to agree on the borrowing for college thoughts. For more info, here's my take on how to get the most financially out of college.


• I hate credit card debt too. But if you can use credit cards correctly, you can make a good amount of money using them. I prefer cash back as a credit card rewards system and that's why I list the best cash back credit cards on my site.


• Ten percent is a good place to start saving, but you do need to up that as the years go on, as I said when I discussed the 10-10-80 budget.

Any thoughts to add?

Financial Strategy #5: Maintain Your Own Personal Bailout Fund

The book Your Stronger Financial Future: The Eight Essential Strategies for Making Profitable Investments lists eight misconceptions, truths, and strategies to help readers deal with a variety of major financial issues. I'll be highlighting these in several posts and giving you my thoughts on them.

Today we'll look at strategy #5 which deals with the necessity of having an emergency fund. The book says the following on this subject:

• The misconception: Government bailouts are for the insiders, not the people.


• The truth: The insiders saved us from a total collapse.


• The strategy: Maintain your own personal bailout fund.

They go on to say that we all should have six months of spending money in our emergency funds during "normal" times and nine months of expenses during a recession.

Not a whole lot to comment on this time. I do agree that we all need emergency funds and that the savings needs to be larger during times of economic uncertainty. In fact your actual emergency fund probably needs to be different depending on the overall stability and situation of your largest financial asset -- your career.

We have an emergency fund much higher than six months of expenses and probably need to actually pare it back a bit. But given the current economic climate I'm not ready to do that at this point -- until it at least appears that we've turned the corner.

Most Americans Can't Afford a $1,000 Emergency Expense

CNN Money tells us that most Americans can't afford a $1,000 emergency expense. Their thoughts:

64% of Americans don't have enough cash on hand to handle a $1,000 emergency expense, according to a survey by the National Foundation for Credit Counseling, or NFCC, released on Wednesday.

Only 36% said they would tap their rainy day funds for an emergency. The rest of the 2,700 people polled said that they would have to go to other extremes to cover an unexpected expense, such as borrowing money or taking out a cash advance on a credit card.

I'm not sure if this situation is a result of the poor economy, years of bad financial management by most Americans, or a combination of the two. But it's pretty scary (and pretty sad.)

If they average American household makes $50,000 per year (and that is close to the median household income, I believe), that means they have roughly one week's pay in savings (or perhaps even less). Yikes!!! So much for the traditional three to six months of living expenses in an emergency fund.

If we had a financial emergency, here's how we'd handle it:

• Our first option would be to pay it out of our checking account. We'd charge it if possible to get the cash rewards, then pay it off the next month, but the money would come from our checking account. This could be done for any expense up to a few thousand dollars.


• If it was more than that, we'd pay for it out of current cash flow (my salary primarily).


• If the expense was very big, we'd pay for it from our emergency savings, which is at about eight months of living expenses for us.

How about you? Can you handle a $1,000 financial emergency? Could you handle more than that?

Could You Come Up with $2,000 Quickly?

MSNBC summarizes a study that asked respondents the following:

“How confident are you that you could come up with $2,000 if an unexpected need arose within the next month?”

Apparently, many people can't. Here are some highlights of the findings:

Half of all U.S. households say they "certainly" or "probably" could not come up the funds to cope with such an ordinary financial emergency, according to a new study on financial fragility.

Of households making between $100,000 and $150,000 annually, nearly one-quarter said they "certainly" or "probably" would be unable to come up with the $2,000.

The amount was meant to suggest a major car repair, a co-pay on a medical expense or a home repair. It is far lower than the three to six months' worth of expenses that financial planners typically recommend people have in savings.

Yet 28 percent of respondents said they could be “certainly” unable to cope with the $2,000 expense, while 22 percent said they “probably” would not.

The survey was conducted in 2009 near the depths of the Great Recession, but the findings were broadly consistent with other data about Americans’ financial resources.

Well my faith (which is low) in the finances of the average American is confirmed once again. And just in case you're thinking it's an income thing, it's not (completely). It's an American thing. As cited at the end, citizens of many other countries are much better prepared for a financial emergency than are Americans. The facts are that Americans are, on average, lousy savers.

Given that the average US household makes $50,000 per year (roughly), a 3-6 month emergency fund would need to at least be $7,500 to $15,000 (I adjusted down to $2,500 per month since we're looking for months of expenses -- not income -- covered. Many expenses could be avoided temporarily in an emergency situation.) So to say that they couldn't come up with $2,000 if needed shows that most Americans are way, way, way off target when it comes to emergency funds and/or extra savings.

Personally, I usually have at least $2,000 in my checking account (there's no need moving it out to get any interest since interest is so low these days.) However, if I had a $2k car bill, I'd charge it to get the cash back rewards, then pay it off the next month. But if I had to, I could pay in cash.

How about you? My guess is that there are three primary types of readers here at FMF:

• People who have been managing their finances well for some time and have the $2k readily available.


• People who are younger and/or just started getting their finances on track who may be close to the $2k but might not be there yet.


• People who have a lower income for whom $2,000 is a fortune and as a result they won't be reaching it anytime soon.

Let us know your situation/thoughts in the comments below.

How to Save a Third of Your Income

The Bucks Blog details the experience of how one author used to save a third of her income:

The biggest thing was where my husband and I chose to live. We lived in a one-bedroom apartment long after we could afford to live in a two bedroom or three bedroom. We basically never upgraded our lives after school and just continued living like college students.  . . . We also made sure to always live near public transportation so we only needed one car . . .  and we make sure to cook relatively inexpensive nonmeat-focused meals most nights at home so our grocery bill is pretty low at about $120 a week.  . . .  Another big thing was we use old clunky cellphones that are definitely not glamorous but saved us money, and we skipped cable a couple years ago.  . . .  Just across the board, we tried to live more frugally than we could have actually afforded to.  . . . It’s not like we denied ourselves everything. I think giving ourselves some small indulgences like a nice television made it easier to make the big sacrifices.

So, the key is keeping spending low -- especially on high-ticket items like homes and cars. Who would have ever guessed that? ;-)

It's interesting to note that they are no longer saving a third of their income. They have bought a more expensive house, have a child, have new expenses (like daycare), etc. But they are still saving 15% -- not a bad level at all. And since they are young, they certainly have time on their side -- several decades for the money saved to compound like crazy.

I've been saving a third of my salary for some time now, so I can agree with their basic premise -- live well below your means. Of course, it's much easier to live well below your means if you take my other bit of advice and grow your career/income to its potential. After all, it's easier to save 1/3 of $150,000 (still allowing you $100,000 to live on) than it is to save 1/3 of $50,000 (giving you only #33,333 to get by on), isn't it?

Saving: The Most Fundamental Element of Wealth

The following is a guest post from Marotta Wealth Management.

Everything in wealth management begins with savings. All wealth comes from producing more than you consume. Unfortunately, most Americans are better at consuming than producing.

Have you ever met people who always have enough money to do what they want? Their peace of mind and confidence is no accident. Nor is it luck. It comes by carefully planning their spending and savings. They deny themselves some desires now in order to enjoy financial security later.

The character Mr. Micawber from Charles Dickens's novel "David Copperfield" offered a kernel of wisdom learned the hard way, now popularly known as the Micawber principle. He said (numbers updated), "Annual income $50,000, annual expenditure $48,750, result happiness. Annual income $50,000, annual expenditure $51,250, result misery."

Surplus income is wealth. Deferred consumption is the textbook definition of wealth, which can be used as a capital investment to produce additional wealth. Although by itself money certainly does not guarantee happiness, wealth can enable us to accomplish many goals in life. Without such a surplus we experience Micawber's misery.

Mr. Micawber is memorable for trusting that "something would turn up" to solve his financial problems. Americans are perennial Micawbers. The savings rate in America is abysmally low, and those who do try to acquire wealth are chastised by a punitive tax code. Micawberism, in contrast, has been rewarded so much, it is considered patriotic to shop until you drop simply to boost the economy.

Unfortunately, economics doesn't really work that way.

Most families who become mired in credit card debt do so because they fail to plan for emergencies. These unexpected events swamp their cash flow, and they have to resort to plastic. But cars break down. Roofs leak. And children need braces. We recommend saving 10% of your take-home pay just to meet these unanticipated expenses.

Saving fuels the financial engine that makes the rest of wealth management possible. Whatever your life goals, saving is most likely required to achieve them.

Saving is the logical choice if you have upcoming major expenses. Some families need to save small amounts to meet modest needs. Others have elaborate and expensive plans that require more complicated strategies.

One of the most important purposes of saving is financial independence or retirement. There isn't a simple dollar amount that will be sufficient. What matters is that you have saved enough to support your lifestyle. Having $1 million at retirement doesn't help if your lifestyle requires $200,000 per year. Dying young is never a good retirement plan.

Saving too little or too late requires more extreme adjustments in savings or lifestyle later in life. Worrying about how to meet your financial objectives should not haunt you. You will know if you are on track only if you know what that track looks like and you adjust your course regularly as needed.

Saving is powerful, but it is only half the story. If you do not invest your savings, inflation will erode your purchasing power every year. In contrast, savings that are invested grow and appreciate.

You should know how much to save today to exceed the needs and priorities of tomorrow. At a 10% rate of return, your savings will double every seven years. So for every seven years you delay saving, you are cutting your ultimate lifestyle and net worth in half.

All of this wisdom about saving can be summed up by the suggestion to "Start saving now." Beginning early in life is certainly the most significant factor in building real wealth.

Saving a million dollars isn't so difficult. Investing just $16.20 a day at a 10% rate of return grows to $1 million in 30 years. This phenomenal rate of growth comes simply by having $16.20 more in income than spending each day. By saving $162 a day, you could accrue $10 million after 30 years.

The most successful way to save is to automate your saving plan. Make savings your default setting. Establish an automatic electronic funds transfer from your checking account to your investment account the day after each paycheck is deposited. You won't miss what you don't see.

Making these decisions explicitly is much better than failing to plan and then being forced to take whatever options are still available late in the game with little time left for course corrections.

Comprehensive wealth management comprises many different elements. But saving is the most fundamental. It is like hydrogen, the first and most basic element. By its energy the sun gives us light and warmth, making all life on earth possible. Harness the energy of saving and put it to use for your life goals.

Most families with significant investments are simply the millionaire next door. They live well below their means and save and invest the difference. They grow rich slowly and steadily. Wealth is what you save, not what you spend.

Take control of your savings today. It is the cornerstone of your wealth management plan.

Plan on Budgeting Surprises

The following is a guest post from Marotta Wealth Management.

Thrift is having a sure hand that controls your spending so your spending doesn't control you. The goal isn't to be rich but instead to be thoughtful, industrious, content and thrifty.

To avoid unplanned budget busters, set three rules for your spending: Set a dollar limit, wait at least a week each time you're unsure of a purchase and be aware of the categories where you are most likely to make impulse purchases.

But raising your awareness on impulse purchases is only part of the battle.

Many budgets are doomed to failure because of the challenge of planning for unplanned spending. Here are some of the items you either did not put in your budget or they shouldn't be in your spending.

Interest on debt

The average American family carries close to $10,000 in commercial credit. At 18% interest, that's $1,800 a year or an unnecessary $150 every month per household. If you put that payment into the markets every month over your working years earning an average 10% return, you would retire with an additional $1.5 million.

There's no reason to buy anything on credit. If you find yourself considering an expensive purchase and then trying to find the payments in your budget, you are planning for failure. The only two loans you should even consider are a home mortgage loan and a student loan for an education or training that increases your earning potential. Money makes money. Credit does the opposite. Debt breeds poverty.

Paying bills late

Debt is terrible. Paying bills late is just bad. By establishing a system for paying your bills on time, you will save every $15 payment from getting a $35 late fee tacked onto it. These foolish expenses add up over time and will quickly undo your efforts at frugality.

Many people believe that paying bills as late as possible gains them a few days of extra interest. In reality, a year's worth of interest isn't worth even one late payment. Late payments also hurt your credit score, which ultimately will mean getting charged a higher interest rate. Pay your bill early, and put your efforts to better use.

Organized people are simply disorganized people who have found a system to help them get things done. Don't think being disorganized is an innate unchangeable quality. It is common to everyone before they take the time and effort to get organized.

Pay monthly bills at least twice a month in order to be on time. These cannot be postponed. Many people find the assistance of online bill pay systems invaluable. It may also help to have a calendar reminder system or a bill organizer. Others have their credit or debit card charged automatically so they are never late.

Unknown unknowns

None of us can anticipate all our expenses. Every stage of life brings a whole new set. Perhaps extensive study and research could help you prepare. But it is easier simply to budget 10% for unknown unknowns.

The first question I usually get asked regarding this category is "Like what?" The truth is that even after identifying every expense you can think of, there will still be significant new expenses that may push you toward deficit spending. But every surprise expense is an opportunity to anticipate and plan for that expense in the future.

Insurance deductibles

Review the insurance coverage for your car and home. A deductible and perhaps a 20% copay often apply. Out-of-pocket expenses could run several thousand dollars. It is more important to limit the maximum expense than to make sure the deductible is low. Budget for the deductible and copay expenses.

Medical costs

Medical expenses are rarely planned. To prepare your budget, have some insurance in place that will limit your catastrophic loss. Second, set up an emergency fund that will cover your expenses if they reach that limit.

For families who are relatively healthy, we recommend Health Savings Accounts (HSAs). As long you spend the funds you save on qualified medical expenses, all contributions, capital gains and withdrawals remain untaxed. And like any other bank account, HSAs come complete with debit cards and checks.

To protect you against catastrophic medical expenses, Health Savings Accounts are coupled with a High-Deductible Health Plan (HDHP). The deductible can be as high as $6,000. Because you might be required to spend up to your deductible, you need a savings plan that funds your HSA up to your deductible within two years. For example, if your deductible is $6,000, put $250 a month into your HSA. Once you have amassed at least that amount, you can take comfort knowing you can at least cover your deductible from your medical savings.

We have coverage for a family of four with a maximum out-of-pocket expense of $3,500. We pay $322 a month to protect our budget and cap our potential losses. We are also allowed to contribute $6,150 a year pretax into our HSA. So we know the most our health-care costs could be is $614 a month and we budget for them accordingly.

Unfortunately, "Obama care" threatens to eliminate consumer-driven care like HSAs by requiring minimum packages and removing the freedom to choose using insurance for disaster coverage. Forcing families to have low deductibles and be pooled with everyone else is like requiring grocery store insurance for the first dollar spent. Frugality disappears, and everyone tries to buy filet mignon.

Insurance should be only used for disasters, not everyday expenses, which provides just the right amount of negative feedback. The first $3,500 as an out-of-pocket expense works as a natural incentive to keep medical costs low.

Car repairs and replacement

Your car won't last forever. It will need major repair at some point and ultimately replacement. Decide how much you are willing to spend for the lifestyle you want, and then budget for it. Don't buy a new $30,000 car and think you won't have any car expenses for the next five years. Even if you plan on driving your new car for the next decade, you have to start budgeting for repairs and your next new car now.

Whatever you pay for your car, new or used, start budgeting to purchase another car in five years. Prices will be higher in the future, but maybe you can stretch the time to seven years so it will all work out.

If you buy a new car for $30,000, you must be able to set $6,000 aside every year ($500 a month) for the next new car. Don't borrow to buy a car and then start making payments. That's nearly always a bad idea and simply ensures you won't save, invest or grow rich. If you can't afford to save the payments in advance, you are stretching too much. Buy used or wait.

House repairs

Owning a home and surprise expenses are practically synonymous. The roof might leak. The plumbing could need replacing. A tree may need to be taken down before it falls. The heating or cooling system could need repairs. The carpet will need to be replaced.

Set aside at least 1% of the value of your house for repairs, not enhancements, each year. If you have an older home, increase the minimum to at least 2% of its value.

Emergency travel

Another unexpected category is emergency travel. Family illnesses, weddings or funerals impose themselves on a family's budget with some regularity. Sometimes even family vacations, graduations or other gatherings can strain finances. If you are both of humble means and have a large extended family, your budget could break under the strain. These are not easy decisions.

Here are some alternatives to help you cope. Perhaps you could send a letter to be read or a videotape. Maybe not everyone in the family has to attend. Consider sending a representative. Ask for help with travel or accommodations. I know that family expectations can seem unreasonable, but speaking the truth in love is always a good response.

Avoid sacrificing or jeopardizing the finances of your family simply to attend the birth of another family or a distant wedding. If you are rich in both time and resources, that circle can include a plethora of friends and family. But the rest of us need to be on a more modest plan.

No budget can anticipate every major expense. Life serves up surprises with some regularity. Putting a healthy margin in our daily living expenses gives us the stored resources to weather these major bills and then better plan for them going forward.

Six Levels of Emergency Funds

I always thought there was one basic level of emergency funds -- six to twelve months of living expenses. But in the book The Financial Crossroads, they suggest different levels of emergency funds based on a variety of factors such as the number of sources of family income, the nature of business supporting those sources, and the variability in those income sources. Using these, they come up with six levels of emergency funds as follows:

• 3 months' expenses for dual income household with salaried workers in stable jobs and industries.
• 4-6 months' expenses for single income household with salaried worker in stable job and industry.
• 6 months' expenses for dual income household with variable incomes in stable jobs and industries.
• 7-9 months' expenses for single income household with variable income in stable job and industry or salaried worker in unstable industry.
• 9-12 months' expenses for dual or single income household with variable income in unstable job and/or cyclical or volatile industry.
• 12 months' expenses or more for self-employed and business owners.

It's an interesting list -- and they have a good point. Why should everyone's emergency fund be the same when everyone's need for an emergency fund isn't the same?

Given the above, I'd have an emergency fund of 4-6 months' of living expenses. I'm a bit on the conservative side of things so I have around nine months set aside for emergencies.

How about you? Where do you fall on this scale and do you have that amount, more, or less saved in your emergency fund?

Are There Higher Interest Rates in Your (Near) Future?

The following is a guest post from Richard Barrington, the financial spokesperson of MoneyRates, a freelance writer and novelist who previously spent over twenty years as an investment industry executive.

Sometimes it seems as though bank customers cannot catch a break. Just as the national savings rate reached a decade-long high this year, the interest rates banks offer on those savings shrunk to microscopic levels. However, if you've been disappointed by blah bank rates, hang on. There are at least five reasons to expect those rates to take a turn for the better:

1. The end of the recession. Classically, an economic expansion creates more demand for capital, and thus can push interest rates higher. With some optimistic signs for the U.S. economy, it may be that the end of the long recession is in sight. Besides the cyclical boost to interest rates that could accompany with the end of the recession, a scaling back of government intervention to keep interest rates low would allow them to rise to more natural levels.

2. Inflation. The past year has seen deflation on a scale not experienced since the early 1950s. Interest rates normally offer a small premium over inflation, so a return of inflation would mean a move up in interest rates. Of course, depositors don't really benefit when higher rates result from higher inflation, but this would make it all the more important for depositors to move with the market.

3. A rebound in housing. Recent months have seen a mild recovery in housing prices. If housing demand mounts a more sustained recovery, it will be another factor creating demand for capital, and thus the likelihood of higher interest rates.

4. The threat of protectionism. Recently-announced tariffs on Chinese tires will not by themselves contribute much to inflation, but protectionist measures have a way of escalating. This is another factor that could push prices, and eventually interest rates, higher.

5. History. Obviously, history itself won't compel interest rates higher, but it is a useful guide to what people should expect in the normal course of events. Historically, inflation has tended to run between 3% to 4%. So, it wouldn't take extraordinary inflation, but merely a return to normal to more than wipe out today's interest rates.

The possibility of higher interest rates should do more than give you reason to hope; it should also influence your deposit account choices. It may be wise to keep deposits flexible in savings accounts whose rates will adjust upward without delay, rather than locking yourself into CDs that may keep your interest rate down after market rates have headed upward.

Are You Saving More?

Reports are all over the web that Americans are saving much more now than they have in recent years. In fact, we're saving almost 7% now! Given we were at or near 0% not too long ago, this is a HUGE change! Guess there's nothing like a major recession to get people cutting back. ;-)

Are you saving more?

We aren't. We've always been good savers and are simply maintaining what we've done for years. So our saving hasn't gone up or down -- it's remained constant.

How about you?

Six Months Is Not the Magic Number: Why the Size of Your Emergency Fund Needs to Reflect the Times, Not Conventional Wisdom

The following is a guest post by Ryan Irvine from The Elements of Lifestyle.

For about as long as people have been writing about personal finance, they’ve been espousing the merits of the emergency fund, which, in a perfect world, would contain about six months of living expenses.

If you’re at that point in your personal finance journey, then I applaud you for at least being ahead of the curve.  But notice how I used the phrase, “in a perfect world.”

The current times are anything but.

In this economy, in which gainful employment can no longer be taken for granted and benefits are like found money, six months just doesn’t cut it anymore.  I learned that the hard way recently.

When the financial sector finally crapped its pants last Fall, I was 4 months into my new job (at a bank of all places), working on a project that was supposed to last anywhere from 2 to 5 years.  Two months later, I was shown the door to the worst economy of my lifetime, a fate only compounded by the fact that I lived in a dying rustbelt city.

That was in December, and at the time, I had somewhere between nine and ten months worth of living expenses set aside. Flash forward to June, when I’m only now getting back on my feet. 

Many of my ex-co-workers were not as fortunate.

See, having six months worth of living expenses saved up leads to two basic assumptions: First, you trust your ability to find work within six months in the event that you’re laid off, even if this means having to transplant your life somewhere else.  Second, even though it is just that---an emergency fund---you are perfectly fine with the idea spending the entire amount, knowing full well the amount work it will take to replenish it once depleted.

If this were a year ago, I’m not sure I know anybody who wouldn’t agree to those terms mostly because the first assumption was pretty much impossible (and so the second becomes a non-issue).

But this isn’t a year ago---this is the Great Recession.   In a time like this, your saving habits may need to go from casual and reactionary to proactive and aggressive.

Here’s how to know for sure.

Pay attention to your company’s finances.  Companies are bad hiding imminent doom from their employees---and the market.

Somehow it wasn’t enough that my company was trading at 20 times below its 52-week high: it took a surprise fire sale of my employer to another bank in October before I really kicked my saving into high gear. 

I began operating as though the writing was on the wall---I reallocated every additional non-retirement penny I could squeeze from my paycheck into my emergency fund.  Two months later, I was out of work for the foreseeable future.

If you work for a publically traded company, you’re doing yourself a disservice if you’re not at least casually following your company’s stock price and listening in on earnings calls.  You can get an idea of how well you’re company’s really doing by listening to what your CEO is saying---or not saying.

Pay attention to your company’s workforce.  Your employer’s ability to recruit top talent (or any talent at all, really) is a reflection of their vision and solvency.

About a month after I started with my company, new hiring all but ceased.  As the scope of our project increased, the size of our team didn’t; instead, we were given additional “offshore”---that’s the P.C. way to say Indian---resources.  This was a swift departure from my company’s policy of not outsourcing mission critical new development, and a cause for concern for a lot of people who had been there a lot longer than I had.

Around the same time, a new Database Architect started on contract two cubes over from me.  As I’d soon learn, he was “new” in multiple senses of the word: He kept the book Become a Database Architect in 21 Days on his desk.  Needless to say, he was gone pretty quickly, but as I’d come to learn, really expensive personnel gaffes like this one were becoming a lot more commonplace. 

Indeed, you should follow your company’s culture as closely as you follow their finances.  If either one of those two things seems out of whack, you have cause for immediate concern: Problems in one area invariably lead to problems the other, and both are equally devastating to a company’s solvency.   The first sign of a toxic anything is where employees usually start formalizing contingency plans.

That having been said, not everyone has the liberty of a contingency plan in this economy.  That’s where fortifying your emergency fund becomes all the more valuable while we all wait for this to blow over, even if that means going above and beyond six months.

A New Perspective

The following is a guest post from Glen Allsopp from PluginID.

We are a generation abundant in such fine qualities as impatience, greed, and the need for a quick-fix. The "magic pill" if you like. When it comes to making money, we're the same.

We want the quick, easy, cash generation solution rather than something we have to work for. That's probably the reason so many people fall for the Spanish Lottery scams or give away their details to their long lost Nigerian relative.

Of course, you don't need to make money more in order to have more; you could just start keeping more of what you do get. The art of saving can be a difficult, long, and winding path. One that we constantly veer off due to those elusive impulse purchases and the slow progress which makes us wonder why we do it in the first place.

Instead of viewing saving as some chore or tough task that we need to form into a habit, today I want to look at things from a different angle. I believe the following three steps will help anyone to massively increase their savings due to the ease of application and the natural desire which they instill.

Have Something That You Really, Really Want

If you think back (actually do this) to anything worthwhile in your life, anything of value, that you have been able to achieve or create, you'll find that each example has something in common. The burning desire for the end result. Although this attitude certainly isn't very zen, I think you'll find everyone of your achievements can link back to this.

When I had a medical issue that doctors said I couldn't do anything about, I spent weeks, day and night, researching everything I could. It was this desire to prove the doctors wrong and solve my problem which kept me going. I did, in the end, stumble upon a natural solution.

When I wanted to quit my day job and work for myself full-time, I focused on the end result and how amazing it would be to not have to answer to a boss. It was this desire that turned my side projects from hobbies into real business ventures, and it wasn't long before I was writing my own paychecks.

When it comes to saving, don't think of the practical side of it or the moral side in that you think saving is just the right thing to do (unless, of course, this works for you). Instead, have a goal, a focus, a need to do it. What is so important to you that you would love to be able to save money for? Your child's college fund, a new car, a home?

Write down a list of all the things you would like to attain from saving more money, and pick one that matters the most to you. One that you would work as hard for naturally as I did with my medical issue or with quitting my day job. You must have a burning desire for some end goal that you can achieve through saving, not just some practical benefit from collecting those pennies.

Map Out What You Will Do to Achieve It

It's all fair and well if your goal of saving money is to have a safety net, but if you can't build a strong desire for that, it's probably the reason you're struggling to save your cash. Similarly, there's no point just feeling like you really want something, without having a plan to get there and taking action.

When I wanted to quit my day job, I set out a plan of attack. First of all, I knew I had to come up with some other income source. I had built websites for a few years so decided to focus on making money online. I had a strong urge to succeed and my desire, coupled with persistence, paid off.

You may want to save $10,000 for a car, or $150,000 for a house, but you need to know how you'll do it. Could you take out the daily Starbucks in your life? Could you start making your meals at home rather than eating out so much? Could you save a tidy $10,000 in 10 months on a $2,400 salary? This guy did.

Work out what it is that you really want, and set aside a plan of action on how you can achieve it. This will be a lot easier than it seems if you have picked an end result which you desire. The first step in this post is crucial to success in this second part.

Re-Frame Everything Towards Your Desire

Reframing is a very powerful technique and its application can be used in a vast number of situations. To give you a good example of this, let's go back to my own situation. When I knew I had to make more money from my websites, I needed to market them and increase the number of visitors they were getting.

Most of my sites were niche based and static. However, I also ran a blog. And, one of the best ways to grow a blog is to write for other blogs to show their audience the type and quality of content you have on offer. It would have been easy, and natural, for me to frame writing for someone else in a negative manner.

For example, I could have viewed it as:

• Giving someone else free content

• Doing a lot of work for little reward

• Yet another article that I have to write

If I had of viewed it that way, I'm sure my progress would have been a lot slower and the work would have seemed that much harder. Instead, I viewed it differently. I focused on the end result; I told myself that this article gets me one step closer to leaving my day job and becoming my own boss.

Can you see how you can use re-framing for your own saving habits?

Instead of moaning about the fact you're biking to work in order to save cash, see it as $5 towards your new car (or whatever your desire is).

Instead of cursing the world because you're having home-made sandwiches for lunch, see it as more money closer to getting what you want.

If you can get the first step in place, I guarantee the following 2 will be far easier than you imagine. Everything in life only has to be as difficult as you want to make it.

Maybe it's time you adopted a new perspective.

Numbers for 2009

Money magazine lists the following "numbers to know" in its January issue:

• $16,500 -- 401(k) contribution limit (50 and older: put in an extra $5,500)
• $5,950 -- Family HSA contribution limit
• $106,800 -- Maximum amount of earnings subject to Social Security taxes
• $5,000 -- IRA contribution (50 and older put in an extra $1,000)

Here's how we stand on each of these:

1. Yep, we'll fully fund our 401(k) in 2009 -- just like we have been for years and years now.

2. Yep, we'll put the max in our HSA.

3. Ouch! I just hope I get SOMETHING back from SS for the boatloads of money I (and my employers) have put in.

4. We also contribute $5,000 for each of us to IRAs (non-deductible).

How about you? Where do you stand on these numbers for 2009?

Do You Store Cash at Home?

Anyone store cash at home? If so, where? And how much? And why?

Personally, I keep about $300 around at all times, but that's not really a significant amount. If we wanted to, I guess we could keep some in our safe, but not sure why I'd want to do that.

One thought -- we all could use the toilet storage method discussed in the link above -- maybe that's why dollar coins were invented. :-)

Anyway, what do you do regarding storing money at home?

Some Good Economic News

Here's some good economic news from US News:

According to a just-released study from Principal Financial Group, 56 percent of workers and 69 percent of retirees have an emergency fund. Nearly a third of those workers say their rainy-day stash could cover more than six months of living expenses, should they get laid off or hit with a big, unexpected expense.

These numbers are waaaaaaay higher than I would have guessed, so maybe we are all better savers that I thought. Then again, maybe the study was faulty. ;-)

Are You a Saver?

Here's a piece from MSN Money that lists what they think it takes for a person to be called a saver. They say that you are a saver if you:

• Save more than 20% of your earned income each year.

• Spend and give away less than 3% of your total net worth each year.

• Increase your net worth by more than 5% from year to year.

Here's where I fall on all of these:

1. Yes, we save more than 20% of our earned income each year.

2. Not exactly sure what they're talking about here. Our net worth is always increasing (unless the market tanks like this year), so we don't lose anything (much less 3%) -- if that's what they are suggesting (which I think it is). I find it hard to believe that they mean you spend/give an amount that's equal to less than 3% of your net worth (for instance, if your net worth is $1 million, then you'd have $30,000 to spend/give.) This seems overly restrictive and not very likely. So I'm going with the first option (and thus we meet the criteria.)

3. Over the past 12 years or so (how long we've been tracking our net worth), we've seen average annual gains in the 16% range. That will drop big-time when this year's numbers are factored in, but it will still be way above 5%.

Given these responses, we would be classified as savers. How about you?

Are You Saving More?

This piece from CNN Money says that Americans are saving more (as well as paying off debt) because of the poor economy. Is this what you're doing as well?

I'm not. My debt is already paid off and I have a good-sized emergency fund. I'm keeping up my 401k contributions as well as my regular investing, but I'm not stockpiling cash. That said, it's not a bad idea to increase your emergency fund in these uncertain times (from the "standard" three to six months of living expenses to maybe six to nine months of living expenses.) In addition, paying off debt is a guaranteed return on your money, so that's not a bad idea anytime -- whether or not the economy is in the tank.

So, what about you? Are you putting more in cash and/or paying off debt more aggressively due to the current state of the economy?

My Trip to the Movie Almost Netted Me a 7% Interest Checking Account

I finally went to see Batman a couple weeks ago. I can't stand huge crowds at theaters (I don't like the talking, limited seat options, etc.), so I waited a few weeks for the response to die down, went to a 5 pm show (saved $2 on the price of the ticket by going before 6 pm!), and saw it in a theater with six other people.

As usual, I had a coupon for a free regular popcorn (normal price of $3-$4). I got this one at a community event in a nearby park -- they were attached to free samples of popcorn. Anyway, the bags offer free refills, so one regular-sized bag is great -- eat until it's gone, re-fill, repeat the process until it's full. And my theater offers do-it-yourself "butter" topping and seasoned salt so you can make it however you like it. I know, it's about the most unhealthy thing you can eat, but since I don't do it that often, it's not going to kill me.

I got to the movie about 20 minutes early and had two full bags of popcorn before the movie started. As I was munching down, an ad popped on the screen for a "7% interest checking account" at a local credit union. The ad was up for about 10 seconds, but I saw "7% interest" and thought "wow, I'd like to get some of that!"

I didn't catch the name of the credit union and they didn't show the ad again, so I searched for the offer online a few days later. Sure enough, I found a local credit union offering 7% interest checking. But, as I suspected, there were several catches. For example, here are the guidelines to get the 7% deal that I can see from the website:

• It's only good on balances up to $2000.00.
• You have to sign up for direct deposit to get the deal (and have at least $200 direct deposited each month).
• You must "actively use your CWCU debit card". Not sure what this means since they don't say. Instead they suggest you call or stop by for details.

What a waste of an offer. I currently have a boatload of cash earning barely anything as I wait to buy a new home. I would LOVE for it to earn 7% (or anywhere close to this), so I was initially very excited about this potential deal. But the fact that it's only good up to $2k makes it not worth the effort. I might be willing to jump through the other hoops if they let me put a ton more into the program, but for the amount I'd make, it would not be worth my time, changing around my accounts, etc. How disappointing!

Anyone else seen offers like this out there? Anyone using one of them?

The Reason You Need an Emergency Fund

This story pains me -- but serves as a good example of why we all need emergency funds. (For background, see this post.)

I hope they get it fixed and it doesn't cost them an arm and a leg.

Unusual Saving Method Nets $12k

Check this out:

Three years ago, I made a decision that changed my relationship with money: I stopped spending, and started saving, every five-dollar bill that passed through my hands. Squirreling away each and every $5 received as change from a cash transaction didn't require any complicated savings strategy, but it has paid off, to the tune of $12,000.

Anyone else out there have some sort of unusual way to save money that's worked for you?

Do You Save More than 10% of Your Salary?

Do you save more than 10% of your salary? If so, you're in the minority. Here's a fast fact I found in the June issue of Money magazine:

Less than one in three Americans puts away at least 10% of income according to the American Savings Education Council.

Between my 401k (not counting the employer match), 529 savings, Coverdell accounts, SEP IRA, and taxable accounts, we save about 20% of our income each year.

How about you? How much do you save of your income?

Help a Reader: Where to Save Cash

Here's an email question I received recently:

I feel very knowledgeble about long term investments.  I feel I manage my retriement savings very well and this has been a top priority.   Over the past 5 years, I've cotributed all additional income to long term savings.  I have:

1) Maxed out ROTH IRAs for myself and my wife
2) Maxed out my 401k
3) Maxed out a HSA and I pay all expenses out of pocket so my HSA grows at the best rate

Now I just got a raise that will result in about $10,000 in after tax money available by the end of the year.   I wand to move in approximately the summer of 2012.   My current home is worth about $180k and I may likely move into a home valued around $400k.  I want to have my current home paid off by then.   Now, paid off could mean literally no balance or having the equivalent savings.

My mortgage is at 4.875% for 15 years.   So, its not very valuable to just pay toward that.   What investments would you suggest for the $10k for a time frame of 4.5 years?   

What would you suggest for him?

Help a Reader: What to Do with Extra Money

Here's an email I received from a reader recently:

I have a question for you that I've been rolling around in my head for a while, wondering if I can get your opinion …

• I am 23, earning $47K a year

• I have $13K in a MMSA (money market savings account -- currently earning 3.5%) and am contributing (after the company match) 12% in my 403(b)

• My only debt is $13K in student loans and 13 years left to pay them. $10K of this is at 2.6% and the other $3K is at 4.5%

• I have been paying just the minimum on the student loans, but am considering taking $3K to pay off the higher-interest one in one lump sum

• Aside from $5K as my emergency fund, all of my savings is there for a "someday" house and/or a "someday" wedding.  The soonest either of these would happen is in 2 years, but I am aiming for that ideal 20% down payment, which in my area, takes a LONG time to save for.

What do you think?  Pay off the smaller loan, or keep the cash in savings?  Either way, I will continue to save about 35% of my take-home pay in the MMSA.

So, what advice would you give her?

10 Commandments of Personal Finance, Commandment #1: Thou Shalt Create a Savings Plan

Bankrate offers a list of the 10 commandments of personal finance that I'll be sharing with all of you as well as providing my thoughts on their selections. The commandment for today:

I. Thou shalt create a savings plan

He recommends you create a savings plan with 20 percent of your income. In fact, he helps his clients create a 24 percent solution. That means, they save 20 percent of their income and only spend 4 percent of their invested assets.

She suggests that a three- to six-month emergency fund should be established.

Hard to go wrong with these suggestions, though saving 20% of your income is a bit high for most people. I'm fine with 10% and hope for 15%, but 20% may be pushing it.

As for the emergency fund, I'm a big believer in having one. That way, when an emergency arises (and you know that one will -- you just don't know what it's going to be), you won't have to make a charge on your credit card that you'll need to pay off over several months (while incurring heavy interest charges.)

For related thoughts on this topic from Free Money Finance, see these posts:

• How Much You Should Be Saving

• Idea for Saving: Put Your Change in "Savings" Every Night

• Secrets of Successful Savers

Click here to read part 2 of this series.

Simple Trick to Help You Save Money

Here's a useful tip left as a comment on my post titled Idea for Saving: Put Your Change in "Savings" Every Night:

If you keep close tabs on your expenditures in a tool like Quicken, there is a way that you can simulate a loose-change piggybank. First, create a rolling transaction in your checking account dated a month in the future and with a category of "Loose change". Every time you enter a transaction, determine how much change would be required to take you to the next dollar. For example, if your grocery bill is $92.73, your "change" is $0.27. Add $0.27 to your rolling "Change" transaction to set it aside for investment and make sure it won't be spent. Then, once a month, take all the money you've set aside as "Change" and move it to your savings account or some other investment vehicle. I haven't tried this yet but it's pretty tempting and I might do it at some point.

I'm not big on "tricks" like this to make me save (I don't have any trouble saving on my own), but I do understand that many people need/could use something like this to help them accumulate a good amount of money during the course of a year.

Idea for Saving: Put Your Change in "Savings" Every Night

If you're like me, you have loose change laying all over the place -- in my desk drawer, in the kitchen area where I keep my briefcase, in the pantry (our "official" change collection site), on my bedroom dresser, in my car's ash tray, etc. It's not a lot, probably $30 or so at most, but this it can add up if you save it purposefully. And that's what one Indiana man did. He saved up his change -- enough to buy three cars over 36 years. Here's the story:

Brant began saving all his change when he started his own family. For 23 years he emptied his pockets into containers around his house. Then, he decided it was time to spend it.

"I wanted a new truck, and when I realized how much I had saved, I went ahead and decided to buy a car for my wife, too," he said.

He had saved approximately $36,000 in change. But Brant wasn't surprised. "As long as you don't put your hands back in the till, it really adds up," he said.

It was 1994 when Brant purchased a Dodge pickup truck and a Dodge Neon with his savings. He had all of the quarters rolled, drove them to the dealership and paid for his new vehicles.

He did it again on Friday, 13 years later.

I must admit, this is a very "creative" way to save. But I'm not sure it's for me. For one thing, what about the interest he missed out on? Yeah, it's not a ton, but it would have certainly added up given the fact that the time period was so long. And for another thing, I don't have that much change anyway. I pay mostly by credit card or check -- cash is probably my least-used method of payment.

How about you? Anyone out there use the "change" method of saving money?

Secrets of Successful Savers

The following article is courtesy of ARA Content.

If you’re unsure what you can do to successfully grow your savings account, you’re not alone. Just like committing to a regular workout routine and eating healthier, getting out of the starting blocks is half the battle. Beginning a savings program is no different and according to a recent national survey, the majority of Americans are not following the three simple steps that are key to a successful savings plan.

The survey, conducted by Harris Interactive on behalf of Countrywide Bank, FSB, the nation’s third largest federal savings bank, shows that the majority of Americans who have both savings and checking accounts keep them at the same bank; they have never thought of having the accounts at separate banks, and have no automatic savings plan in place.

“Consumers are potentially leaving money on the table,” says Pierre P. Habis, managing director for deposits and investment services at Countrywide Bank. “Serious savers view their savings accounts as ‘one way’ only, meaning they make more deposits than withdrawals. They succeed at this by keeping their transactional banking relationship at one bank and savings at another.”

“We’ve found that if consumers’ checking and savings are under the same roof, it’s too easy to draw from that nest egg, and that’s when savings stagnate,” he adds.

So what are the three secrets of successful savers? Habis offers the following advice:

1. Separate

In the Harris survey, 71 percent of respondents said they keep their savings and checking accounts in the same bank. And 67 percent have never even considered separating their accounts. This, Habis says, can be a serious mistake.

Keep your primary savings and checking accounts at different financial institutions. This strategy may help you get the best rates, and will make it more difficult to dip into your savings – one of the worst saving mistakes people commit. Shop around for institutions that offer the best possible terms. It is possible that the institution that best meets your checking needs might not be suited for providing market-leading savings rates.

2. Automate

Sixty one percent of the respondents in the Harris poll do not automatically transfer or deposit a set amount into their savings on a regular basis. Paying yourself first is one of the hallmarks of a basic savings plan. Habis recommends that consumers establish a savings plan, whereby a percentage of your income, or a set dollar amount, is automatically deposited into your savings account on a regular basis. “Start out by trying to allocate a small amount, perhaps even $20 per week to start, towards a high-yielding account,” says Habis.

3. Shop for the Best Rate

If you’re not sure what the annual percentage yield (APY) is on your savings account, how do you know if your money is working hard for you? According to the survey, 32 percent of adults with savings accounts don’t know what the yield and corresponding interest rate is, and 45 percent know that it is less than 5 percent. To find the best rate, survey several banks and compare the APY on your savings accounts, money market accounts or certificates of deposit.

Avoid leaving money on the table by ensuring that your account has market-leading savings rates. Web sites such as www.bankrate.com help consumers identify the highest rates available in their market.

“As with any financial decision, consumers should carefully evaluate their options and fully understand the advantages and disadvantages before making a change,” Habis says. “Consumers can maximize their returns if they separate, automate and always seek the best rate.”

Help a Reader: A Problem We'd All Like to Have

Here's an email I received recently from a reader:

I’m in a great quandary and need some help.  Here’s my situation:

• Newly married, so I have 20+ years until the college bills start.
• Already maxed out 401k for 2007 and don’t qualify for Roth IRA.
• No debt aside from mortgage (30 year fixed mortgage @ 6.5%)

I just found out I’ve maxed out my 401k this year and I have 3 pools of money to invest:

• $60,000 cash
• $1,200/month (my 401k contribution)
• $30,000 in bonuses coming between now and the new year.

What do I do?

• 529s/college savings?
• Pay down my mortgage?
• Mutual funds or other taxable investments?

What would you do if you were me?

Isn't this a problem we'd all like to have? :-)

I faced a similar situation several years ago, but certainly not at the young (I assume) age of this reader.

Ok, so he's maxed out his 401k. Where would you advise him to put the rest of his money?

Where Do You keep Your Short-Term Cash?

Here's a reminder from Bankrate that you should keep any money you'll need in the next couple of years in a very liquid account like a money market. The details:

I'm with you and agree that you should be investing conservatively when you have an investment horizon of two years or less. CDs, money market accounts (MMAs) and money market mutual funds (MMMFs) are all good choices. CDs typically aren't as liquid as the other choices with penalties for early withdrawal.

We keep our short-term money in a Vanguard money market. It earns competitive rates and makes it easy to buy Vanguard funds if I decide I want to move some money from short-term savings to long-term investments.

How do you manage your short-term cash? Where do you keep it?

Americans Giving Up Earnings on Cash

Here's an interesting statistic I found in the August issue of Money magazine:

More Americans use a piggy bank (42%) or change jar (65%) than a money-market account (35%) according to Capital One.

A few thoughts on this:

1. As a commenter recently pointed out, statistics can be manipulated to say almost anything, so it's hard to read exactly what's going on here.

2. That said, it appears that many Americans are using techniques to save money that aren't optimal. For instance, a money-market account pays about 5% or so per year -- a change jar's return is significantly below that. ;-)

3. Maybe this isn't a big deal. It could be that while a greater percentage of people use non-optimal savings methods, a greater percentage of the dollars saved are still in accounts like money-markets. We just don't know from what we're given.

4. So what's the action point? I think if you're saving a few dollars in a change jar, that's fine. We do it (to pay the kids now and then) and I don't think we're losing a fortune as a result. On the other hand, if you've got a few thousand dollars in coins and bills lying around, you'd be much better off putting them into an account where your money is working for you.

How to Save Money: Hide It from Your Spouse

Here's an interesting comment left on my post titled The Richest Man in Babylon: Seven Cures for a Lean Purse Part 7, Increase Thy Ability to Earn:

We are a family of five and we had a difficulty in saving because my wife is presently unemployed. I started putting 10% of my salary in a (secret) savings account without my wife's knowledge. After a few deposits I decided to tell her how we can save money and showed her how I have been saving. She was amazed. She asked me to continue with the idea which will ultimately lead to bigger investments. This is an excellent book for any one who wants to know about financial freedom. I am very happy to have read this book.

Now I don't generally recommend hiding things from your spouse as a regular financial planning technique (and I don't use it myself), but I could see where it would have merits in certain circumstances.

Anyone else use this method? What's worked with it? What hasn't worked?

Reap the Benefits of Direct Deposit -- Without Direct Deposit

The following is a guest post from Cheap Like Me -- where economy and ecology meet:

In just about any advice you read about saving money, you'll come across a line like this: "Pay yourself first. Have a portion of your paycheck automatically deposited into a savings account …"

Great advice. Just one problem: Millions of Americans are self-employed or earn mostly cash pay (from writers to artists to waiters to other tip-oriented professions) and have no paycheck, and therefore no direct deposit.

But the automatic savings advice is doable for independent contractors and the self-employed -- with a bit of extra planning.

• Plan for taxes. If you are self-employed, you probably pay quarterly estimated income taxes. Job One is to be sure you set aside funds to pay the IRS. Figure out your estimated tax bill (a worksheet is available here). Save for this bill in a business savings account or a separate personal account. Set aside 1/12 of the bill every month, or a percentage of every check -- whatever works for you.

• Bill yourself. To pay yourself first for taxes or any savings goal, set up savings as a bill that simply must be paid. If you wouldn't let down your mortgage company, don't let yourself down, either. Add the amount to your budget. If you use Quicken or other money management software, add savings as a "scheduled transaction" -- a bill that reminds you to pay it each month, along with the phone and insurance. (I have several of these "bills" set up for tuition, my daughter's summer camp, investment savings, etc.)

• Be old-fashioned. If you deposit your checks or cash in person or by mail with a deposit slip, be your own direct deposit. Ask the teller to put a specified portion of your deposit immediately into savings, just the way Grandma used to do with her passbook savings account. You'll reap the benefit of never seeing a pre-savings figure in your checking account.

• Get to know online banking. Find a bank or credit union with free online banking. Make a note on your calendar to transfer your designated amount to savings as soon as the money comes in. On that date, go online and make the transfer - no changing your mind, no extra spending.

• Go automatic. Almost as good as direct deposit is automatic savings. With an online savings account, you can schedule an automatic transfer from your checking account to your savings account on the same day of each month. This too will help you see the transfer as another bill.

• What if you're offline? Even if you pay bills in cash and use a bank seldom or never, you can still pay yourself first by using the envelope system. Budget a savings amount and put it in a specific location. Be cautious as the cash adds up -- you're not only at risk of losing it (through theft or the urge for a sudden splurge), you're also missing out on the benefits of interest income.

• Hands off. Keep track of your savings, but make them difficult to access. If you sometimes hit bottom on your checking account, which in turn pulls from your savings to make up the difference, you can erode your savings without even noticing. An online account is a great way to keep your stash out of sight, out of mind.

With patience and commitment (you're paying this bill to help yourself, after all!) you will see your savings grow. Best of all, anyone can do it.

Do you have other ideas about how to save when you work outside the mainstream? Please chime in.

Help a Reader: What to Do with $42k in Cash?

Here's an email I received recently:

I have been reading your site for a while now and wanted your opinion. I have about 42k in cash, I have been putting it away for a while. I have calculated until Dec 2009, with the same savings rate and interest payments from HSBC to amass about 102k. My 5 year ARM will adjust in Jan 2010 from the current 4.75%. I was thinking of dumping all the cash into my mortgage to basically pay it off. I know you’re an index fund advocate, so would the 2.5 years be a long enough time to keep a portion of the cash, say 35k, in a couple Vanguard funds, VFINX and VDMIX?

Other info: I’m 30 and single with no dependents. I have been fully funding a Roth IRA since 2004. I put 20% of my pay into 401k, not quite meeting the federal limit, but my company only allows 20% max. My company matches 5% dollar-for-dollar.

I told him 1) 2.5 years was not long enough to put money in a stock fund and 2) that I'd post this and let you all comment on it. Have at it -- give him your best advice.

How Much You Should Be Saving

Here's some advice on how much each of us should be socking away in savings from the book The Net Worth Workout: A Powerful Program for a Lifetime of Financial Fitness (see my rating for details):

Generally speaking, I think that a good goal is to be saving 10 percent of your gross income by the time you're thirty years old. If you're a woman, I'd suggest you shoot for 12 percent, because women tend to earn less, live longer, and pay more for products and services like haircuts and drycleaning.

Incidentally, when I say 10 percent (or 12 percent), I'm not including whatever your company may match for your 401(k) plan. Because the company match is "free money" from an outside source, it's not really coming from you. It's best to use the company's match as part of your total savings cushion.

My thoughts on this:

1. As a GENERAL rule, I'm ok with 10% of gross (not net) income. However, I prefer people go to the trouble to estimate the actual expenses of what they are saving for (retirement, college, etc.) and then save accordingly. This may put them at 6%, 9% 12% or 15%. That's ok to me -- it's a better estimate of what they'll actually need.

2. I think it's ok to count 401k money as long as it's yours (in other words, as long as you're vested for the amount in your plan.) What's it matter what the source is, it's still your money isn't it?

3. I've been at the 15-20% level of savings for several years now -- and 10-15% before that. It takes a lot of money to save for something like retirement (as I found out when I set my retirement number) so even while I'm saving a high percentage, I need to.

For more on saving for retirement (the biggest savings expense most of us will have) see these posts:

• How to Maximize Your Retirement Savings

• Save a Little Bit a Day and Become Rich

• Saving Ten Percent of Your Salary for Retirement is Not Enough

• Facts on Retiring Early

This is Why We Have an Emergency Fund: The Sump Pump Breaks Down

In Michigan, we're still in the transition from winter to spring. Yes, the rest of the world has been enjoying the new season for a month now, but since we live in the tundra, we're a bit behind the times.

A couple weeks ago, we had a HUGE rain which melted almost all of the last remnants of snow (some spots remained in big parking lots where they had piled it high.) Well, when it rained, we got an unexpected surprise. And it seems our emergency fund will be used soon to help out the matter.

We were eating dinner when our neighbor knocked on the door and told us we had water running down the side of our house starting where our sump pump emptied. This is never news you want to hear -- but it's even worse when you've just sat down to start a nice steak off the grill. Anyway, I bundled up and went outside. Sure enough, there was a stream that went along the wall of the house and ended in a small lake under our deck in the back yard. The problem? The drain that was collecting water expelled from our sump pump was clogged (I could feel the clog with a stick about 2 feet down -- but it twisted, so I couldn't get my arm in there to unclog it.)

So the sump pump was pumping water out of the basement, the water was hitting the drain, and since the water had no place to go, it ran under the deck. The water then, in turn, was collected by our system that drains water from our house, run into the sump pump again, and the process repeated -- about every two minutes the pump ran trying to keep up with itself.

So I called the plumber and he came out the next day. Seems like a clogged drain is common (leaves, dirt, etc.). What's not common is a cheap way to fix it. He suggested we wait a bit to see if the drain wasn't just frozen and would unclog itself. Otherwise, we'll need to dig it up and put a new one in. He wouldn't give me an estimate (that will come later) which leads me to believe that it will be a decent amount of money. Yep, that's what an emergency fund is for.

He put a temporary drainage hose on the pump's external tube and the water now empties into our woods (which is working pretty good, though it looks like crap since it's above ground.) By we're safe from a flood for the time being. That is until a chipmunk decides to make his home in our new tube. ;-)

Help a Reader: What Should He Save for First?

Here's a question I received last week from a reader:

I'm a college student (22) who will be graduating in a few months, and I'm just starting to get my finances set up properly. I have a few questions.

You talk a lot about retirement accounts (ROTH IRAs and 401ks), but I was wondering about other things you'll need money for long before retirement. Weddings, cars, houses, etc. I've traditionally heard that you should save 10% of your income (though I think you suggest 20-30%).

What portion of that should go to retirement and what should go to short term savings for cars and houses? Because you can't put short term savings into retirement accounts, where do you suggest it be put (high interest online savings accounts, CDs, non retirement investment accounts). Is it a good idea to get that money tied up in stocks, which may or may not be at a good price to withdraw at when you need it?

I told him I'd open up the questions for all of you to answer since you all are smarter than I am. ;-)

Let him know what you think in the comments below.

How to Create an Emergency Fund

Your son has just backed the car into the garage – literally!  Your company is downsizing and giving you an unpaid sabbatical.  You painfully remember why Dad told you to hire out roof repair.  Unfortunately, financial emergencies are a fact of life.  And they’re the reason most financial planners recommend establishing an emergency fund to cover unexpected expenses or loss of income. 

An emergency fund is enough savings to cover three to six months of living expenses such as rent, food, car, and utilities.  The money should be kept where it can earn decent interest (not a bank savings account or under the mattress) and where you can access it quickly without loss or penalty (not a CD or IRA).  Money-market funds, mutual funds made up of safe, income-producing assets, meet both these criteria and are the best choice for most savers.  Visit Bankrate.com for a comparison of money-market funds.  Finally, experts suggest you annually re-evaluate your emergency savings needs and adjust accordingly if your income, debts, and expenses change.

Perhaps you want an emergency fund but just don’t have the resources available at this time.  Don’t despair.  You can create it over time.  Here are some tips you can use to build your emergency fund:

• Aim for a lower savings goal initially, like a month’s worth of expenses. As your income rises, invest more.

• If you have credit card debt, consolidate it at the lowest possible interest rate, stop using the card, and make the minimum monthly payment.  Use your available cash to save one month’s living expenses, then pay off the debt.  Once the debt is gone, add to your emergency fund.

• Use “bonus” money such as gifts and tax refunds to build up your fund.

• Consider an extra job.  It doesn’t need to be a long-term or regular commitment, but any extra income can go straight to your fund, helping establish it very quickly.

• If you hate the idea of another “regular” job, put your talents to work.  Do you enjoy cooking?  Working on cars?  Making crafts?  Tutoring?  Sell homemade goods, offer private lessons, or teach a class to earn income.

• Turn spare change into an investment.  Empty pocket change into a container each night, then at week’s end deposit the funds.  A couple contributing $1 each daily will collect $730 annually. 

• Sell extra items.  Most people have stuff stored throughout their house that will never be used.  Create cash by selling those things at a garage sale.  Or visit your local consignment store to turn “trash” into cash. 

• Have extra space or are you an empty nester?  Why not rent an unused room to a college student or single person?  Or, if you dislike the thought of sharing your home, rent to others who need storage space.

Follow these simple steps to start building your fund today.  While you can’t stop the surprise financial challenges we all face, your emergency fund can help prevent a bad circumstance from becoming a disaster.

49% of People Don't Have an Emergency Fund

Here's one for the "yikes!" file from Money magazine:

49% of respondents in a recent survey conducted by Quicken said they had no emergency fund stashed away.

Holy cow! Are you kidding?

Having an emergency fund is one of the basic building blocks of good money management. If almost half of the population is missing it on something so simple and basic, imagine how many are in trouble on the more complicated issues related to financial planning!

For more thoughts on getting/having an emergency fund, see these links:

• Get an Emergency Fund Now!

• Financial Emergency Kit

• Where to Save Emergency Cash

How to Save $500 for an Emergency Fund

Here's a piece from Money Central on how everyone needs to have at least $500 in an emergency fund. It includes some very disturbing information on what percentage of various age groups have less than $500 in the bank including:

• Under 35 -- 34.5%
• 35-44 -- 25.1%
• 45-54 -- 22.1%
• 55-64 -- 19.0%
• 65-74 -- 18.8%
• 75+ -- 14.9%

It's unclear to me whether this data is actually "in the bank" literally or if it means "has $500 saved." If it's the former, it's not as bad as many people may not have $500 in an actual bank but may have thousands in a money market or similar savings account. However, if it's truly "these people have less than $500 saved in total," then these are numbers that make me say "yikes!" Especially the numbers at the bottom -- as people get older. We have just under 20% of the people older than 54 who have less than $500 saved. If this is true, it certainly is disturbing.

Fortunately, the piece goes on to list a few ideas on how you can get $500 including:

• Use your tax refund.
• Try a "buy nothing" month.
• Sell stuff.
• Save your change.
• Review your bills.
• Make it automatic.

Some decent ideas. #1 alone is a $2,200 idea (on average), so it should get many people to $500 -- if only they can find the discipline to save that amount.

In addition to these, you may want to think about some of my ideas listed as part of my quest to raise an additional $10k this year in income -- extra income outside my regular job. Here are some suggestions:

• Turn a Hobby into an Income

• Make Money with Credit Cards

• Sell Stuff You Own

How to Pay Yourself First

Here's a great comment left on my post titled How to Find Money to Invest. The reader shares some good (and simple) steps we all can take to automate our savings/investment plans. His thoughts:

Good list! I think the easiest way to accomplish this is simply by doing number 1 and pay yourself first. I know it has almost become a cliche, but it really is true. This is exactly how I am able to scrape together money for investing also.

If you have direct deposit of your paycheck, then there is no excuse for not paying yourself first. All you need to do is set up a separate account at your bank, checking or savings, whatever is free and doesn't have weird minimum or withdrawal limitations. Then change your direct deposit to put a little money into this account as well. Maybe it is $10 per pay, maybe it is $20, or even $100. Whatever you decide to do, make sure that the account isn't linked to your debit/atm card so it is hard to get access to.

Next, just link up your brokerage account to this bank account and you are all set. As you build up the account you can easily make investment purchases from that separate account. You can even go one step further as most mutual funds allow for systematic purchases as low as $25. So you can then setup a systematic buy that coincides with your deposits and then everything is automatic. Not only are you paying yourself first, but you've created an automatic process towards building wealth.

This is what I do, though my process is slightly different. My steps:

1. My entire paycheck is placed into my checking account (after money has been deducted for my 401k, of course.)

2. I have a set amount that gets transferred to Vanguard automatically each month.

3. The Vanguard money is then automatically invested in a handful of funds according to my investment objectives.

It's simple, easy, and once it's set up, it's all on auto-pilot. I'm saving/investing without even doing anything!

How Much You Need in an Emergency Fund

Here's another item on Money magazine's list of 25 rules to grow rich by. Today's tip gives some thoughts on how much you need to have saved in an emergency fund:

Keep three months' worth of living expenses in a bank savings account or a high-yield money-market fund for emergencies. If you have kids or rely on one income, make it six months'.

I think this is good advice. Personally, we follow it -- keeping six months of living expenses in a money market account.

If you're looking for ways to build your emergency, consider cutting expenses or taking steps to make more money.

How Much of Your Salary You Need to Save

Here's another item on Money magazine's list of 25 rules to grow rich by. Today's tip gives some thoughts on how much of your salary you need to save:

If you're not saving 10% of your salary, you aren't saving enough.

The earlier you start saving, the less you'll need to set aside every year to meet your goals. That's because you allow your money more time to grow -- the gains on your invested savings will build on the prior year's gains. That's the power of compounding, and it's the best way to accumulate wealth.

Saving at least 10% of your annual salary for retirement is recommended, but the older you start saving, the more you'll need to save. If you start at 50, you may need to put away 30% a year and still postpone retirement by a few years.

Personally, I'm a big fan of the "save more earlier" strategy. That's what I've done -- tried to put as much away as possible as early in my life as possible so then the power of compounding do it's magic. It's just starting to kick in for me in a big way -- my investments are just now starting to deliver substantial increases from year to year by themselves (even if I didn't keep contributing to them.)

So, how have I managed to save this much? It starts with spending less than you earn. If you do this through the years, you can become quite well off. (By the way, if you're having trouble spending less than you earn, you may want to check out my past posts on how to save money and how to make more money.)

I then take the money I've saved and invest in my 401k (where I get free money from my employer in the form of a match) as well as in taxable accounts. My preferred investment vehicle is index funds.

Simply do these simple steps over and over again for years, and you're bound to get rich.

All About Emergency Funds

Here's a piece from Money magazine on emergency funds. It answers the three key questions most people have about emergency funds as follows:

What's it for? Your reserve fund is for the curve balls that life is bound to throw at you: a leaking roof, a blown transmission, a hot water heater gone cold. It's also for unexpected life changes, like the loss of a job, a divorce, or a major illness.

How much should you have? The equivalent of three to six months' worth of living expenses is a good guideline, but take your own situation into account when deciding. If you're part of a two-income household, you might be able to get by on the other income if you lose your job, for example. If you're self-employed and have an irregular income, you might need more to see you through the lean times.

Where should you keep it? Since you'll be tapping these funds in an emergency, it's essential to be able to get the money quickly and conveniently. A savings account, a money market account or a money market mutual fund will all keep your money highly liquid, while paying you a bit of interest. Shop around for the account that will give you the best rate with no monthly fees.

Here's what we do:

1. Of course we have an emergency fund. All of you reading this would grill me if I'd been dishing out finance stories for over a year and didn't have this simple financial step covered.

2. We are on the conservative side, so we save six months of living expenses. Besides, we are a one-income family, so we should be a bit conservative.

3. We keep our fund in a Vanguard money market account. It doesn't earn quite as much as some other options, but it makes shifting money back and forth among our various Vanguard accounts very easy.

If you don't have an emergency fund, you should start taking some steps to get one. Cut some expenses or follow some of my suggestions for making more money and you should have a good-sized emergency fund set up in no time.

How to Develop a Great Emergency Fund

Here are some thoughts on developing a great emergency fund from financial expert David Bach. He lists four steps to doing this. They are:

1. Make your rainy day fund automatic.

2. Get your emergency money out of your checking account.

3. Put it in the right place.

4. Decide how big a cushion you need.

He then suggests places to look to get the highest interest rates possible including:

• Look online. (ING Direct and EmigrantDirect)
• Go to your bank.
• Invest automatically with government savings bond.

A few thoughts here:

1. We keep our emergency fund money in a Vanguard money market fund. It earns a bit less than ING and ED, but means we have to manage one less account and it's easy to get money into and out of (and dollar cost average with Vanguard mutual funds).

2. We have six months worth of living expenses saved. I prefer to be conservative -- so I go for six versus three months.

3. Our emergency fund is fully funded now, so we don't have to make it automatic. But it was automatic when while we were accumulating it.

4. You must, must, must have an emergency fund. If you don't, then any financial emergency (and these will pop up for all of us) will force you into debt. Start saving today -- even if it's just $20 a month. Start small and work up if you have to. If you keep with it, you'll have a good amount saved in a very short amount of time.

Which Should You Do First: Establish an Emergency Fund or Pay Off Debt?

Lots of reader comments on my post asking which should be done first -- establish an emergency fund or pay off debt. And, as you might imagine, they didn't agree with each other (or with me). ;-)

First, here's what I suggested as a complete way to handle this issue:

1. Spend less than you earn. This alone is THE key to getting rich. Said another way, save a portion of all you make.

To spend less than you earn, you may need to earn more or spend less.

2. Contribute to your 401k to get the full employer match.

3. Pay off your credit card debt.

4. Establish an emergency fund.

5. Pay off all other debt.

6. Invest your savings regularly in good, solid investments. I like index funds.

7. Do this for a long time, letting the power of time and compounding work for you.

Here's what the first commenter had to say:

Although you shouldn't sacrifice building up your emergency fund, there is an additional factor to consider. As you pay off debts, your monthly minimum expenses go down. One of the most important measures of your emergency fund is how long you can live off of it. Emergencies can change that. If your car is totaled, you may find yourself buying another car before you expected to. I went through that two years ago.

The choice isn't clear-cut. Money used to pay off debt isn't available in savings. However, money in savings goes farther when you have fewer debts to cover.

Good point about monthly expenses going down as you pay off debt.

Here's a bit of a different perspective:

I do love Dave Ramsey's method: Build up a $1,000 emergency fund first, then kill off the cards with a vengeance. After that, finish building an emergency fund.

It keeps people from going back to the one thing that got them in trouble - small charges to credit card. Granted a big problem may happen, but most of the issues people have are $1000 or less, such as getting the car fixed or calling a plumber.

I also like Dale G's point. Once those cards are paid off, your emergency fund will last that much longer. I calculate my minimum burn rate every month to get an idea of how much money I'll need to live on.

Finally, here's a vote from the "save first" crowd:

Step one in getting out of debt is deciding not to get in any more debt. By paying off debt without any emergency fund, the first emergency that comes along, you are going to add to the debt.

Get a small emergency fund to cushion you from life. Then payoff the debt.

I've been there, and knowing that we had 1000 dollars just in case made a huge difference - and the emergencies did come. And we did not get in more debt.

It's kind of a chicken-and-the-egg sort of question to me. What do you think -- and which do you do/are you working on? Should paying off debt come first or building up an emergency fund?

What to Do with a Financial Windfall

Here's a piece from Money that gives their advice on what to do with a financial windfall. It's an answer to a question about what to do with $3,500 a reader came into. Here's the bottomline of what Money says to do -- the main choices being between investing in a Roth IRA and paying down credit card debt:

From a purely financial point of view, the decision comes down to this: Do you think you would earn more on your investments in the Roth account than what you pay in interest on your credit card debt? After all, by using the money to pay off your credit card balance, you would save money in interest payments, and that would effectively be the "return" on your $3,500.

Yep. This is exactly the way I'd think about it. And Money details my next thoughts exactly:

You don't say what you're paying on your plastic, but according to the credit card section of Bankrate.com, interest rates have been recently averaging anywhere from 10.1 to 14.3 percent, depending on the type of card you carry. It's possible, I suppose, if you were an extremely skillful (or lucky) investor, that you could average that sort of return over several years. But I doubt it. So that would seem to make paying down the credit card the better choice.

I'm with them 100%.

Then they make a u-turn on me:

But you know what? I don't think that would necessarily be the smart thing to do. In fact, I think there's a strong argument for opening the Roth anyway, if not with the entire $3,500, then at least a good portion of it.

Here's my thinking. One of the biggest problems we face in America is that we just don't save enough for retirement. You can find any number of reasons for this - it's easier to spend than save, we're too into immediate gratification, etc. - but one way or another it ultimately comes down to the fact that we don't stick enough money into savings accounts, including Roth IRAs.

Now, I'm a big of saving early and often for retirement. In fact, I know that doing this can make you rich. However, I disagree with this advice. I'd go with paying off the credit card first -- locking in the guaranteed rate of return -- then saving for retirement with the money I had been paying to the credit card company. Of course, this assumes that the person doesn't go out and re-charge his card up to the hilt. Otherwise, the Roth is probably the better choice. At least the money is semi-safe from his free-spending ways.

And the piece doesn't mention this option, but if the guy had a 401k at work and wasn't contributing enough to get the full employer match, I'd rate that over paying off the credit card. Why? Better return. Much better return in fact as it would mean 50% to 100% back on your money most likely (based on your specific plan).

By the way, this is a similar question as what should you do with a tax refund or a raise. As such, I give a similar answer. ;-)

Pay Debt versus Establish an Emergency Fund versus Saving -- Which to do First?; Free Money Finance Guide to Saving, Investing, and Paying Off Debt

There's an on-going debate around what you should do if you're in debt: pay off your debt first or establish an emergency fund, then pay off the debt. My basic philosophy was detailed in Comments: Over One-Quarter of the Population on the Brink of Financial Disaster, Need Discipline where I stated:

I recommend paying off the debt first because: 1. it's costing you money (a lot) that's digging you deeper into debt and 2. if you pay it off, it's not like that money's gone. You can charge again if you HAVE to (if you get into trouble financially) This has the same effect as saving money for future expenses. However, if you save first, you're paying interest on the debt the entire time you're saving. Doesn't seem like a smart move to me.

To add a few more specifics to this, here's what I'd recommend as the order:

1. Pay off high-interest, credit card debt.

2. Establish an emergency fund.

3. Pay off other debt.

To add to the debate, here's a piece from USA Today that throws another element into the mix -- saving (in particular, for retirement). They give some thoughts on paying off debt versus establishing an emergency fund versus saving for retirement. But first, they tackle the debt versus emergency fund issue. Their thoughts:

The return on paying off debt is roughly equal to the interest rate you pay. Many credit cards charge 18% or more: You'd be hard-pressed to find another investment earning 18%. "It's like giving yourself a risk-free 18% return," says Don Lutomski, a financial planner in Birmingham, Ala.

Consider a couple with $10,000 in credit card debt. They paid 18% interest. The credit card company requires them to pay at least 4% of their balance each month, or $35, whichever is larger. If they paid just the minimum, they'd be paying for more than 10 years. Total interest: $5,575.

But if they paid $100 more than the minimum each month, the couple would end up repaying the entire balance in 50 months, a bit more than four years, saving $2,285 in interest. Best of all, they would have wiped out their debt, boosting their cash flow by $265 a month.

By contrast, the returns from a savings account seem paltry. Had you stashed your $100 a month into a bank savings account paying 5% for 50 months, you'd have about $5,424 in your account at the end of the period. You would have earned just $425 in interest.

This is the same rationale that I use when recommending that people pay off credit cards first. Financially, it's just the better option of the two.

But USA Today isn't making this a firm recommendation. They hedge their bets a bit here, noting later in the article that emergency savings are important too (which I agree with), especially when you lose your job. As such, here's their recommendation:

Your best strategy: Build up your savings at the same time that you pay down debt.

Now that's useful advice, huh? Why not just state the obvious?

It doesn't seem very practical to me to do both -- besides, it really results in no recommendation at all. I'd love to say "do it all" in all of my recommendations, but that's not very helpful in my opinion.

The rest of the article hems and haws and really doesn't make a complete recommendation, so I'll make one:

1. Spend less than you earn. This alone is THE key to getting rich. Said another way, save a portion of all you make.

To spend less than you earn, you may need to earn more or spend less.

2. Contribute to your 401k to get the full employer match.

3. Pay off your credit card debt.

4. Establish an emergency fund.

5. Pay off all other debt.

6. Invest your savings regularly in good, solid investments. I like index funds.

7. Do this for a long time, letting the power of time and compounding work for you.