Insurance & Emergency Funds

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Some things you have took lots of work to acquire. You saved up for years to buy that car or home. There are yet other things you didn’t pay for, but are even more precious, like your health and strength. For the average American household, if any of these costly assets were to be seriously damaged or destroyed, the way of life for that household would suffer great loss. In this article, I’ll show you how to make insurance and emergency funds work together to help you manage financial risk.

The financial industry cooked up this thing called insurance. When you buy insurance for something, you basically pay someone else to take on the risk of the possible loss associated with that particular item. For example, you own a car. You paid $22,000 for your new wheels and you only have $5,000 cash to your name. A rich guy says, “Hey, Hot Rod, don’t you know that there are over 17,000 auto accidents per day? What would you do if your $22,000 set of wheels got totaled today?” You answer, “I’d probably be broke with a bus pass.” He responds, “If you give me $150 a month, I’ll pay for anything that happens to the car that costs you over $500.” You say, “Sounds like a deal to me! Where do I sign?”

That’s insurance in a pea pod. Most of the time, insurance is a great deal because it’s fairly cheap compared to the potential loss of the insured item. There are times, however, when insurance is not necessarily a good idea. For example, if you owned a car that was worth $1500, it wouldn’t be a good idea to pay $150 a month in premiums to cover the potential loss because the loss would not be so great that it would alter your life in a major way and you would probably end up paying more in insurance than the car is worth.

For small to medium sized items, you should self insure with an emergency fund. Every household budget should contain some sort of emergency fund. No matter how big or small your income or net worth, you should always keep enough cash on hand to help cushion the blow of most common financial calamities. Most financial gurus suggest keeping at least enough on hand to cover your living expenses for 3 to 6 months. I like to say, that’s a good starter fund. In the full blown Life Without Loans! world, I want you to work your way up to a whole 5 years worth of living expenses. I want you to Katrina-proof your finances!

I don’t want you to be silly though. Remember that there are rich people (insurance companies) that don’t mind paying for your big ticket items, if you regularly pay them a small fee. These insurance guys aren’t all the way crazy though. They usually make you foot part of the bill when something goes wrong, so make sure you have enough money in your emergency fund to cover those deductibles. For example, if you have a $1,000 home owners insurance deductible, a $500 auto insurance deductible, and a $5,000 health insurance deductible, you’d need at least $6,500 on hand to cover you if all these things were damaged around the same time. Now, if you opt for a lower monthly insurance premium, you’ll have a higher deductible, and vice versa. Be careful and know what you’re able to handle as far as premiums coming out of your cash flow, and having money sitting around to cover deductibles.

That’s an overview of how to make insurance and emergency funds work together to manage risk and help pad financial falls.

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