I’ve done a good job of sharing my disdain for Dave Ramsey’s popularization of a method of getting out of debt that caters to unmotivated individuals, the “Debt Snowball” method. That doesn’t mean I don’t agree with his principles or his intentions. I just think he, as one of the most popular “gurus” in personal finance, has to cater to the masses. It makes sense for him to profess a methodology that is simple reaches people on an emotional level. Real financial planners who work one-on-one with individuals to get out of debt and formulate a lifetime financial plan would be able to supply better options.

Dave Ramsey does offer something I like, his “Baby Steps.” These are seven suggestions that, when followed sequentially, will do wonders for helping people struggling with their finances to take ownership of the money in their life and start moving towards a more prosperous future.

Here are Dave’s suggestions, verbatim:

• $1,000 to start an emergency fund
• Pay off all debt using the Debt Snowball
• 3 to 6 months of expenses in savings
• Invest 15% of household income in Roth IRAs and pre-tax retirement
• College funding for children
• Pay off home early
• Build wealth and give!

In general, I like this plan of action. These “baby steps” help someone ease into a pattern of new, financially responsible behavior, with small mini-goals which when taken in full view go a long way to help ensure financial stability.

These “baby steps” are designed to appeal to a large mass of people. This is not advice based on any one individual’s real situation, so it’s fair to apply some customization and perhaps even improvements. Here are a few small criticisms.

Is $1,000 enough or too much for an emergency fund base? Dave Ramsey suggests shoring up a $1,000 cash cushion before beginning to pay off debt. Although $1,000 is a finite number of dollars, its value has a different meaning to different people or to different families. A family with an income of $250,000 a year and $1,000,000 in debt may not consider $1,000 to be much of anything, while a family earning $20,000 per year and $100,000 in debt might find the saving of $1,000 to be a struggle. So what’s a better option? I would suggest that this base savings, what is needed to lay the groundwork before embarking on the great debt reduction journey, should be one months’ expenses, whatever they happen to be. That sets a high enough starting goal.

The “Debt Snowball” method is not so great. Despite its popularity and proven track record with a million dollar business marketing this method, I’d like to see more people give a real try to the Debt Avalanche. They’ll save money and time in the long run if they are intrinsically motivated. I’ve discussed this at length before.

Is it too soon to worry about college funding for children? I’ve heard experts suggest that parents should make sure their retirement is fully funded before worrying about funding education for their children. I don’t think saving 15% of household income, unless begun at a young age, will get most parents to a secure retirement, but that depends on the family’s needs at that later date. There are too many variables to predict that with any accuracy. The reason most experts suggest this is because you can borrow money for college, but you can’t borrow money (as easily or inexpensively) for retirement.

I strongly believe that parents have a responsibility to ensure that the best educational opportunities are available to their children, but with the prices of tuition increasingly well beyond the rate of inflation, I’m not sure how well that philosophy will work in the future.

Why pay off the mortgage early? Dave Ramsey is strongly against holding all forms of debt. Mostly, I agree. If the mortgage rate is low enough, and you have the fortitude, risk tolerance, and availability to invest the funds you would otherwise use to accelerate your mortgage payment in an asset allocation designed with a long-term time horizon, it may make more sense to pay just your minimum to the mortgage. But I won’t stop anyone who wants to pay off their mortgage early, even if they might end up with a lower net worth than if they had invested. The market is unreliable, but when paying off a mortgage early, you’re guaranteed to “earn” the rate of interest you’re being charged. It’s not a precise way of figuring the math, but knowing that you don’t have to pay interest that was originally included in your amortization is good.

Thanks go to Dave Ramsey for popularizing good general advice.

Having an emergency fund, money set in an easily accessible location like a savings account earmarked for certain situations, is one of the first steps to being financially secure. This is common advice, particularly among financial advisers. Ideally, one wouldn’t tap the emergency fund at all. That sacrifices some earning power because even high-yield savings accounts lose ground to inflation. In return for that sacrifice comes some stability. With an emergency fund in savings rather than the stock market, you don’t have to worry about a potential loss if you need the money in a down market.

If you can plan in advance and protect yourself, you can help reduce the sting of an emergency.

There is, however, a difference in opinion about which circumstances qualify as emergencies. The biggest emergencies would arise with any event that eliminates an income source for an extended period of time.

Legitimate emergencies

Sudden job loss. For many people, the primary source of income, and thus the ability to pay for expenses, is a job. Most people in the United States trade their time and effort for a paycheck, relying on a company, small or large, to accept that time and effort and provide remuneration. When job loss is sudden, the primary source of income could disappear just as quickly. Very few of us are “entitled” to a severance bonus, providing a cushion to ease the fall for a period of time, so we must plan accordingly.

It’s dangerous to place your ability to earn income in a sole decision maker focused on a company’s bottom line. As an individual, we each must take our income into our own hands as much as possible, and that includes always being prepared for job loss. Part of that preparation involves having an emergency fund available, keeping a current resume, networking with colleagues, seeking recommendations, and studying the industry.

Even with preparation, the loss of a job can be damaging to your finances, and the effect can last long after you find your next job.

Death or medical emergency of a family member. While life insurance can help deal financially with death, it doesn’t cover everything. There is an entire industry designed around planning for death, but an emergency fund will always be necessary. As relatives age or gradually experience a decline in health, you have time to develop expectations and prepare financially, but unfortunately, death is not always this graceful. Emergency funds can be used to help pay for these hopefully infrequent events, from flights to visit distant family members to final arrangements.

Acts of nature. In New Orleans prior to Hurricane Katrina, residents wary about hurricane damage to their homes were encouraged to buy insurance policies covering wind and rain damage. Many insurance policies provided no relief following Katrina because the damage done to homes was determined to be due to flooding. According to USA Today, only one-third of homes carried federal insurance which included protection from flood damage. Many residence thought they were covered in the event of a hurricane, but the insurance companies disagreed.

A typical emergency fund with three to six months’ worth of expenses may not have solved all problems in this situation, but it could have helped. Natural disasters are not always as damaging as Hurricane Katrina, and planning for total destruction will in most cases be excessive, but when designing an emergency fund, it’s helpful to factor in what is likely for your location.

Car accidents. Auto insurance is generally helpful when it comes to covering for damage due to car accidents, whether caused by you or another party. Often, insurance won’t cover everything you need. Your emergency fund may need to at least cover your deductibles, but also fill in any gaps left after payments arrive. The fund can help pay for a new car if needed.

Surprise tax bills. While review and planning should prevent this occurring, occasionally the IRS finds something overlooked. It happens to even the most diligent. The IRS will usually allow a payment plan to extend repayments over time for an additional fee, but an emergency fund can help cover the liability.

Delay in income. I used to work for a non-profit which, before I had started working there, had a nasty reputation of not keeping enough funds in their payroll account to cover the paychecks for the ten or so on staff. I’ve had friends working for start-up internet-based companies who were asked to forgo paychecks for a time period for the good of the company in its initial building stages. With an emergency fund with three to six months’ expenses, you won’t be in danger of failing to cover your bills. Once the paychecks catch up, you will be able to re-establish the emergency fund.

If delays in income extend longer than six months—personally, I would only accept this from an employer for a month at most, if at all—it is time to find a new job, if possible.

Sudden relocation. Usually, if your employer determines that your job should move from New York City to Ogden, Utah, they will compensate you for your relocation. That isn’t always the case, and your option may be to forgo opportunities within your company and business by quitting your job or accepting the relocation and the accompanying expenses. The decision is personal, but it’s better to be prepared to face the consequences.

What does not qualify as an emergency?

I’ve heard of people using emergency funds for expenses that are clearly not emergencies. While everyone’s definition of an emergency is different, if you want to make the best use of your money, I would suggest not tapping money earmarked for emergencies for these expenses. That said, you can save separately for these expenses.

Vacation. It’s great to get away from your daily responsibilities for a time, but even if your therapist recommends an immediate vacation, you shouldn’t dip into the money set aside to cover emergencies.

A buying “opportunity” in the stock market or real estate. If you’re interested in timing the market or want to buy a house for the fun of it, save separately for the occasion. Most people overestimate their ability to time the market and could find themselves on the losing end of an investment at the moment they need the cash for a true emergency.

Out-of-town visitors. You just heard your friend from college would be in town for a weekend, and she’s suggested getting together for an evening out. If you don’t have extra cash flow at the moment, you might want to suggest a frugal option. Don’t feel you have to impress her by going to the fanciest restaurants and clubs, particularly if you have only your emergency fund available.

Mid-life crises. Recently divorced and quickly aging? It’s time to buy a convertible sports car. That seems to be the accepted path, but it can be a dangerous road to travel, particularly if your ex-wife has half or more of your money. Don’t dip into your emergency fund to buy a new sports car just because you want to feel young again. It may, however, be time to get together with an old college friend for an evening out.

Keeping up with the Joneses. The Joneses buy what they buy because they have no problem with debt. If you’re conscious about spending, you’ll never keep up with the Joneses in the accumulation marathon, nor should you feel the need. They’ve added a sun room and an in-ground swimming pool, but for all you know, they could be paying for it for years. Resist the temptation to match or exceed appearances, whether with debt or by tapping the emergency fund.

What do you think?

I’m sure there are many emergencies and an infinite number of non-emergencies I’ve neglected to mention. I will also bet the total of my emergency fund that some readers will disagree with some of my classifications. (Gambling: not an emergency; Paying your bookie: possibly an emergency.) Please share your thoughts.

Photo credits: au_tiger01, daveynin, and rayced

Earlier today, I asked via Twitter how much everyone has in their emergency fund in relation to their monthly expenses. Here are some of the responses. (I assumed if the message wasn’t sent privately and if the twitter account wasn’t protected that I could re-post the source of the responses.)

• nodebtplan: 3 months of expenses in our emergency fund
• takingcharge: currently only enough to get me through a month or less, but working on saving enough for 3-6 months
• taliaishere: 3 months in the emergency fund, but am working towards 6 months-that would be much more comfortable
• Gblogger: Depends on what I count—we stopped segregating specific emergency funds a while back. But at least 6-10 mos.
• dreamscostmoney: 3-5. It used to be 3, but then I decreased my monthly expenses, so it’s probably closer to 4 or 5.
• BurgBarbL: I have about 1.5 months’ worth of expenses in my emergency fund.
• Private: In my emergency fund? One. Not great, I know. But with my new salary, I’m on a plan to make that three.
• SunFinancial: I don’t have a dedicated emergency fund. All are accumulated in one savings account.
• bargainr: 9 months

Among these responses, the average (while taking the low end of anyone who responded with a range) is about 3.5 months. Not bad! I have about 3 months’ worth of expenses in my account called “Emergency Fund,” but I have about an additional four times that amount across a variety of savings accounts.

If you’re interested in participated in occasional polls, follow me on Twitter. For those who don’t know, Twitter is a “social media” tool that allows you to broadcast and receive quick and short text updates. I promise not to send spam or to bombard you with “new post” updates. Mighty Bargain Hunter has a list of 118 personal finance bloggers who use Twitter, but many only provide automated “new post” notifications, duplicating an RSS feed.

One of the most popular pieces of financial advice is the importance of establishing an emergency fund, money that can be accessed to assist with life unexpected problems, like medical emergencies or the loss of a job. Financial advisers like Suze Orman suggest that most people have ready three to six months’ worth of expenses in “liquid” savings—easily accessed—ready to go to help cover a rainy day.

I’ve suggested breaking your emergency fund into five components, but it’s the first two components that relate directly to the nearly universal definition of the emergency fund. Having cash on hand and in liquid bank accounts will help you deal with a sudden loss of income or a significant financial need, but money kept in this manner loses value over time due to inflation. Any money kept in the emergency fund is not maximizing earning potential as other investments could be. The goal is to find the right balance between allowing your savings to earn money though compound interest or appreciation and forgoing performance for accessibility.

How do you determine how much to keep accessible? As I mentioned, many experts suggest having three to six months’ worth of expenses ready to go. That’s a wide range and not very helpful. For example, for me, that could be anywhere from $12,000 to $24,000. Here are some questions to help you determine a more personalized amount.

Start with your monthly expenses. If you already track your income and expenses somewhat accurately with software like Quicken then you have your starting point. Keep in mind that your monthly expenses for this purpose include your spending plus your debt payments. Include your electric bill, even if you pay by credit card. If you have outstanding debt, include your monthly payments for your credit card, mortgage, student loans, or any other service that applies.

Look at the stability of your income. What would you do if you lost your job? Are your skills in high demand? If so, you may find a replacement for your income quite quickly. If this is the case, you have an argument for keeping the balance of your emergency fund on the shallow end. While your personality will determine how much risk you’re willing to take, and you are taking more risk by keeping a small emergency fund. Even though you may perceive your ability to find a new job earning the same amount will allow you to find you a new job within one month, it would be beneficial to assume that forces possibly beyond your control will prevent you from doing so.

Keep in mind that job markets cycle, so you may need to reevaluate your situation from time to time. Labor demand and supply change. If you established the “rules” for your emergency fund in 1999 when high tech jobs were in high demand, if you had lost your job in 2002 you may had been out of work for longer than you expected.

How far are you willing to go? If you might have difficulty finding a job to replace your income, are you willing to consider alternatives? Some people are willing to do whatever it takes to make ends meet, even if it means taking a job for which they are overqualified. If your industry suddenly becomes unfavorable, will you work as a waiter for minimum wage while determining the next course of action? If you need to devote all your waking hours to find a new job, then you’ll need a larger stash than if you can split your time between the job hunt and a temporary job.

How much would it cost to move? I would say that an unexpected necessary move would be a strong use for an emergency fund. If your job is requiring you to move to a new town and they are willing to pay for your expenses, you do not need to worry about this, but there are many other reasons why you might need to find residence in a new town. For example, perhaps a family member could become ill and you need to move closer to provide care and support. Consider your variable moving expenses as well as any expenses you might have while you settle in your new location. These should be covered by your emergency fund. If moving requires a new job, add more to your emergency fund to cover your expenses.

Are you willing to reduce your expenses? Desperate times call for acts of desperation. Chances are you have expenses you can eliminate if you are out of work. If you’re willing to say goodbye to high-definition cable television, the wine of the month club membership, and the gardener, feel free to leave these expenses out of your calculations when determining your ultimate emergency fund goal. But only do so if you’re truly willing to give up these luxuries.

It is rare to hear someone say, “I had just the right amount in my emergency fund.” Almost always you will have too much or too little, but those who have too little drive the most popular stories. It’s next to impossible to foresee all possible situations and plan your emergency fund perfectly. It’s best to err on the side of caution even if that means you’ll have less available for investing. Accept the fact you won’t get it exactly right and do the best you can.

The savings account I label “Emergency Fund” has about two months’ worth of expenses, but it’s held at ING Direct. If I needed this money in cash, the quickest way to get the money would be to to transfer the amount to a local bank account and withdraw the funds. This process would take a several days, so I have in place a multi-level emergency plan which consists of cash on hand, money in ING Direct’s account, more money in several high-yield savings accounts, and, if necessary, I could sell investments (and draw a tax bill) or use available credit (and risk the need to pay interest expenses).

One of the first steps to cleaning up one’s financial situation before embarking on the journey to become financially independent is the establishment of an emergency fund. An emergency fund, in its most basic form, is an accessible savings account where you keep cash for true emergencies, like the loss of a job or a medical emergency. Financial advisers and writers often suggest that emergency funds should contain enough cash to cover all expenses in a three to six month period.

Beyond the basics, I suggest at least five separate components to an complete emergency plan. Getting to that point presents challenges for many people. When one is starting out, it can be difficult to assemble the basis for eventual financial freedom.

Here are 50 tips for the beginner who may be pressed for money.

1. Open a high-yield online savings account with as little as one dollar.
2. Sign up for direct deposit.
3. Empty your pocket change into a jar every night.
4. Bring your coin jar to the bank every month.
5. Add to your jar every time you swear.
6. Have a garage sale.
7. Whenever you purchase groceries with a coupon, deposit your savings into the bank.
8. Downgrade your telephone service.
9. Bring your own lunch to the office.
10. Ask for a raise (with substantiation).
11. Drink soda rather than alcohol when you’re dining out.
12. Drink water rather than soda when you’re dining out.
13. Switch to store-brand food items.
14. Switch to generic medication.
15. Cut back or eliminate your addiction to smoking.
16. Be aware of your ECRD Factor.
17. Create an automate deposit to your savings account.
18. Divert your raise into the bank
19. Don’t consider your emergency fund part of your spending money and keep it hidden.
20. Celebrate America Saves Week every week
21. Tutor a young student in a subject you know.
22. Get a part-time job at your favorite book store or coffee shop.
23. Use a cash back rewards credit card and deposit your rebates directly into your emergency fund.
24. Call the cable company and cancel your service (or agree to a better deal).
25. Save gas by not driving faster than 65 miles per hour.
26. Stop using credit cards if you pay interest.
27. Cancel your Netflix subscription.
28. Fire your gardener and do the work yourself.
29. Visit the library rather than your local bookstore.
30. Stock up on non-perishable groceries when they are on sale.
31. Consolidate your student loans.
32. Cancel magazine subscriptions.
33. Reuse any items you can rather than buying new, and pocket the difference in your emergency fund.
34. Delay vacations until your emergency fund is complete.
35. Sign up for online bill payment if your bank offers the service for free.
36. Shop around to ensure all your your financial accounts do not charge you extraneous fees.
37. Always know how much you have in the bank so your accounts will never be overdrawn.
38. Consider switching your land line phone service to an internet (voice over IP/VOIP) service.
39. Use public transportation rather than driving when possible.
40. Work a few extra hours at your day job.
41. Call your insurance provider and ask for an updated quote.
42. Shop around for a new insurance provider.
43. Troll the web for abandoned and unclaimed property owed to you.
44. Negotiate in any retail environment. The more you try, the less you’ll spend (and the more you can save for emergencies).
45. If you travel, join AAA; the discounts will often pay for the membership fee.
46. Don’t be an early adopter of new technology.
47. Cancel your gym membership.
48. Check your three free credit reports each year from annualcreditreport.com, the official website, for accuracy.
49. Consider adopting a frugal philosophy, at least until the emergency fund is in place.
50. While paying attention to small, repetitive expenses, don’t ignore larger decisions like your car, house, and wedding. With smart choices on big-ticket items, you could fully fund an emergency account with the savings.

With a goal to be financially independent, the first step is securing a cash cushion, accessible in emergencies. During this funding phase, it may be beneficial to make sacrifices that in other situations you would not make. A slight decrease in quality of life in the short term will likely outweigh long-term financial devastation when a future emergency arises.

If you’re a Type A credit card user, chances are you know it whether or not you are willing to admit it. If you can answer yes to these questions, then a lifestyle change is in order.

• Do you pay interest fees when you send in your credit card payment?
• Have you ever paid your credit card late because you didn’t have the money for the payment?
• Do you use your credit card when you don’t have enough cash?
• When your issuer raises your credit limit, do you spend more because you can?

Type A credit card users are loved by the issuers. They pay interest and late fees. Between that income and the interchange fee the cards charge the merchants for each transaction, the card issuers’ business plan is to get Type A credit card users to spend more.

On the other hand, Type B users, who don’t pay interest or fees, are shifted to cards with higher interchange fees. For example, Citi switched me from a Dividend Platinum MasterCard to a Dividend World MasterCard. The main difference between the two cards is the RFID chip that allows transactions without physical contact, but the hidden difference is the higher charge merchants pay to accept the card. (Also, like the larger trend in the credit card industry, the cash back rewards have been reduced.)

If you’re a Type A user, then it would be in your best financial interest to stop using your credit card, to budget your income, and use cash. While some people can take that advice and get it done, others have built up a psychological dependency on credit cards. Here are 10 steps to break the cycle of dependency.

1. Look at your spending carefully.

Deep down, some know that they are spending more than they are earning and wasting money on interest fees. This fact is ignored at the conscious level; ignorance is bliss. Use software like Quicken, Microsoft Money, Excel, or even a pen and paper to track all your spending for a month, even the quick daily cafe mocha at Starbucks.

Use your credit card statements to compare with what you have recorded. Did you track everything?

This might reveal incredible, depressing detail about your spending. $100 a month at Starbucks or $400 for dining out are not out of the ordinary when looking at these numbers for the first time.

If you continue this for more than a month, you might see your bottom line, or net worth, declining each month. This is not a good sign, and it may be enough to encourage you to change your behavior for a better chance of financials success.

2. Understand marketing.

Society doesn’t want you to curb your spending. Products and advertising are designed to make you believe you need something when you don’t. Even the government encourages spending, especially when trying to boost the economy. President Bush would be ecstatic if everyone took their economic stimulus payment and loaded up on American-made goods.

It’s hard to maintain control when the rest of the world is against you. The sooner you understand that it takes effort to defy the prevailing trend, the closer you will be to being above the influence of marketing.

Being completely above the influence is impossible unless you disassociate yourself from “civilized” society. Accept the fact that powerful forces in the world are trying to manipulate your behavior, and accept the fact that with extensive research they are mostly successful. With this realization comes enough power to resist a portion of those marketing efforts.

3. Commit yourself to change.

You can only change your behavior if you want to change your behavior. A smoker can be told repeatedly that there’s a good chance her lifespan will be shortened and may face halth consequences like emphysema or cancer, but unless she’s ready to quit, all the words in the world would have no effect. Logic and reason often play small roles in human decision-making.

For those with debt accumulation, the problem isn’t the credit card. Credit cards are just tools, but they enable people to spend money they don’t have. If you’re ready to break the credit card habit, understand that there’s a deeper problem to solve. Without credit cards, the most accessible facility for overspending will be removed, and that can be the first step to solving the deeper problem of overspending. That is, of course, if you’re ready to admit there’s a problem and commit to changing it.

Steps 1 and 2 above may help you get to the point at which you’re ready to commit to changing your behavior. Committing to this change means spending less than you earn. You should be familiar with the details behind your income an expenses and have the knowledge to determine where there are opportunities for cutting back your spending and increasing your income.

If you use the credit card for spending more than you have, then you will need to cut back immediately.

4. Consolidate your balances onto one or two cards.

Gather the latest statements for the cards containing balances. Choose one or two with the lowest interest rates and consolidate your balances onto these cards. By calling the credit card company, you can provide the information for your other cards with balances and they will initiate a balance transfer. Ask for a transfer fee waiver. If they aren’t willing to waive the balance transfer fee, consder using a different card to consolidate your balance.

5. Enact a cash-only policy.

Once you consolidate your balances onto one or two cards, you cannot use those cards for spending. You have two options for spending from this point forward: cash or debit. I suggest cash because spending with a debit card can be psychologically similar to spending with a credit card. In order to kick the overspending habit, changing the way you think about financial transactions is important.

While there is a logical difference between spending with credit cards and with debit cards—debit cards are linked to your checking account so you can only spend what you have—if humans were logical they wouldn’t be in debt.

Actually, now many banks allow you to overspend (overdraw your account) with your debit card. Additionally, they charge a somtimes hefty fee for this “priviledge.” If you want to change your behavior, cash-only is the best policy. An empty wallet is a great spending barrier.

6. Destroy your credit cards except for one or two.

Forget all the talk that says closing your credit cards will damage your credit score. Overspending is a larger problem than getting a more favorable rate on your next mortgage. I would suggest canceling almost all of your credit cards. Why not all? While some people might have good results with the “cold turkey” approach, I don’t believe it should be a universal recommendation.

Here’s the proper way to destroy your cards. First, get your free credit report from annualcreditreport.com, the official site that will provide you with your three free reports each year. Inspect the report carefully taking note of every credit card listed. See some unfamiliar cards? Chances are your report contains information on cards you didn’t know you had.

If that’s true, first confirm that these cards are in fact yours. If someone is using your identity to open credit cards, this must be resolves as soon as possible. There’s also the possibility that the credit reporing agency has bad information. Clear any errors quickly by contacting the company that provided you with the credit report, like Experian, Transunion, or Equifax, and disputing the incorrect information.

Next, call the credit card companies for which you do not have your card and cancel your accounts with them. If you don’t have the card, you didn’t even know you were a customer. There’s no sense in keeping a credit line open if you didn’t know you had one and if you’ve survived thus far without needing it. The plan is to reduce your spending, so the simple solution is simply canceling the cards you haven’t been using.

If you consolidated your balances as suggested in step 4, you should have one or two cards with balances and more without. Here’s the dirty secret about consolidation. Now that your your balance is all on one or to cards, your combined minimum payment is probably lower than it was before. Don’t forget to pay at least the minimum to each card, but we’ll tackle paying down the balance aggressively at a later point.

Cancel all the cards not containing balances. As I mentioned above, this is not the savviest approach if you are concerned about your credit score. If you have an overspending habit enabled by easy access to credit, you are not concerned with your credit score. Keep your oldest card if you expect to be applying for a mortgage in the near future, but otherwise, stick with the lowest interest rate.

To cancel your accounts, you have to call the companies. The representative on the phone will try to keep you as customer by offering you lower rates and higher limits. Don’t bother negotiating, even if they offer a lower rate than the card you are saving. The idea here is to simplify, so don’t play any games.

Shred all the now-unused plastic. If you don’t have a shredder that handles credit cards, use a pair of scissors to slice the cards into several pieces. I would even discard of the pieces in different locations.

7. Lock away your remaining credit card.

Now that you have one credit card left, realize that you will not be using this card for everyday spending; for now, cash is king. Put your remaining credit card out of sight. Lock it away. I’ve even heard of some people who put their credit card into a cup of water in the freezer. The extra step of breaking a block of ice to get to your credit may be an extra demotivator.

This final credit card can be used in extreme emergencies until the next step is complete.

8. Build an emerency fund.

This step will take some time. If you have an overspending habit, you’re spending more than you earn. That creates a situation that prevents saving. In step 1 you evaluated your spening. Perhaps you cae across some options for cutting back, allowing you to put money into a short-term savings account.

Open up a high-yield savings account. Many, like ING Direct, allow you to set up direct deposit or an automatic investment plan. Choose one or the other, which ever is the best for you. It’s simpler if you already have a pay check deposited somewhere else to go with the automatic investment plan.

The goal is to save 3 to 6 months of your expenses in this savings account. This could take a long time if your expenses apprach or exceed your income. You’ll have to be creative. If skipping this year’s vacation would help you achieve this goal, then you have a decision to make.

Remember: an emergency fund is to be used in true emergencies only. This doesn’t take the place of your credit card. Te purpose of the emergency fund is to remain untouched for regular expenses but accesible when major spending is required. Some examples might be the loss of a job or a significant medical expense.

For more details, see Five Components of an Emergency Plan, but ignore component number four.

9. Pay down your balances.

While you’re building your emergency fund and paying cash for all your expenses, don’t forget to spend money every month to your consolidated credit card balance. In order to get out of debt, you’ll probably have to pay more than the minimum. There are several theories prescribing the best way to divert all available funds to paying down your debt.

A popular financial guru, Dave Ramsey, suggests what he calls the “Snowball Method.” He suggests ordering your balances (you should only have two at the most at this point) from highest to lowest. To the card with the highest balance, pay the minimum each month. To the card with the lowest balance, send the minimum payment plus any additional funds you have available. Dave believes this will allow you to see success (paying off the first card) sooner, providing a psychological boost, encouraging you to continue.

While psychology plays a large part in terms of money, I believe Dave’s reasoning is faulty. If you put the most money towards the card with the highest interest rate, you might not get the psychological boost of paying off a card sooner, and the time difference may be negligible. You will have a psychological boost from knowing that you will be paying less interest.

For more information, read about the Debt Avalanche, a better snowball method.

10. Check your progress monthly.

If you use financial software mentioned above, you’ll have a straightforward way of measuring your progress. You should see your expenses decreasing each month and your credit card balances decreasing. These monthly reports can be excellent motivation to continue. Your habit is clear in graph form; visuals are powerful. Each month, recommit to spending only what you have.

When changing a behavioral pattern like overspending, don’t expect immediate success. Our society encourages consumerism, and breaking from that trend, like swimming against the current, is going to be difficult. We often do not see the consequences of overspending. We hear about the government bailing out banks for making bad lending decisions and creating laws to protect consumers who purchased houses too expensive.

Don’t let this distract you. In most cases, the consequences a pattern of overspending can be difficult on relationships as well as personal finances. Once you’re ready to change, make the commitment and follow the steps above. Success will come through sticking to the plan.

The most effective emergency fund, for use in the event of a job loss or unexpected major expense, is actually a combination of several types of investments. You should be prepared with a small amount of physical cash to hold you over until you can get money from a bank, highly liquid investments like a high-yield savings account, a Roth IRA (if you qualify) in which your contributions can be withdrawn penalty-free and tax-free, and possibly credit access.

NZbird wrote to suggest an interesting addition to an emergency food: a stocked pantry. By stocking up on non-perishable food items, you will leave more of your money available for use in the event of an emergency.

Keep your food pantry WELL STOCKED. I mean food is an essential right. And if you have kids you don’t want them stressing out because the basics like food aren’t there. So stock up your pantry real good with all the ingredients for meals. I try to keep around 6 months supply on hand. My husband use to laugh at me when I started doing it, but you know it introduced a discipline into our grocery shopping that wasn’t there before… The kids always knew the ingredients were in the cupboard for lunches, breakfast, and any snacks they wanted to make. I believe it’s that feeling of security and hope for the future that must be maintained for the sake of the children in times of job loss.

At first, the thought of stocking up on food seemed more like preparation for a pandemic, but the main point is that if your income is suddenly grounded, you won’t have to worry about spending your emergency fund for food and will have more available for rent or mortgage payments and electricity bills.

Thanks for the suggestion, NZbird!

In an world of overly simplified platitudes and one-size-fits-all “advice,” there is little repeated more in personal finance than the importance of the emergency fund. Typical popular financial advice prescribes a high-yield savings account in which one can store three to six months’ worth of expenses. Suze Orman suggests aiming for eight months’ expenses in a savings account. David Bach believes four months is a good starting point for an emergency fund.

Advice for a fat emergency fund sounds good when high-yield savings accounts are actually providing high yields. When interest rates are low, it can be financially detrimental to leave so much cash uninvested. It may be worthwhile to diversify. Rather than having just an “Emergency Fund,” like a “subaccount” at ING Direct with its own name, this can be only one component of a larger scheme. To encompass all that could be included, perhaps “Emergency Plan” is a better term than “Emergency Fund.”

I am not talking about a box that you keep in the trunk of your car that contains a gas mask, a gallon of water, a hand-crank radio, and a can opener, like one of my coworkers. While that might be helpful for the Y2K bug when airplanes fall out of the sky in midflight, this “Emergency Plan” refers to finances only. There are five components.

1. Mattress cash stash. Obviously not hidden beneath your mattress, having some cash in the house—hidden in a weird place that a burglar would not think to look—gives you access to fast cash if you need to leave right away without any time to stop at a cash machine. Also, if the ATM network is down for some reason, you won’t have any trouble trying to access some money. It would be impossible to predict how much you would need before you could access the banking system in a catastrophic event, so I think the guideline here is just to be reasonable. Maybe keep a couple hundred dollars in cash around the house.

Of course, in the worst situation imaginable, money itself would lose all value and society would be reduced to a system of bartering for what you need. Even gold, which some people claim has intrinsic value that paper money does not (it doesn’t), could be worthless. Don’t bother keeping bars of gold around. The idea is to prepare within reason. Keep this amount as low as possible; money sitting around loses value relative to the things you would need to trade it for thanks to inflation of the money supply.

2. Liquid account. Unless the banking system fails, you should be able to access your next level of emergency fund within 24 hours. With interest rates decreasing every week, it might make sense to seek out better paying liquid investments like money market funds. All of the cash I have earmarked for emergencies, about $10,000 right now, is held at ING Direct, currently one of the lowest of the “high-yield” savings accounts.

It wouldn’t hurt to add layers to this level. This year, I will change my Emergency Plan to leave cash in the amount of expenses for one month or less at ING Direct while increasing my savings at a money market fund that beats inflation like the Vanguard Prime Money Market Fund, currently earning a 4.55% yield. Between my mattress stash and liquid accounts, I want to be able to cover three months’ worth of my current expenses. That’s a little lower than what’s recommended by the gurus, but I chose this amount because the chance of losing both of my sources of income at the same time is low and I believe I could find a new job quickly if necessary.

Bankrate discusses using certificates of deposit or bond funds for this portion of liquid savings, but they are not liquid enough. The interest premium offered over high-yield savings accounts and money market funds, usually small, won’t outweigh the chance of paying an interest penalty for early withdrawal before maturity.

3. Investments. With investments, we’re starting to get into the territory of the money you’d be better of not touching, even in an emergency. The Roth IRA is the first stop if you need to tap your investments in an emergency. You can withdraw your contributions (not your earnings) without penalty, taxes, or fees (depending on your broker). Once the emergency condition has subsided, you can still contribute the money you withdrew back into your Roth IRA.

If you don’t have a Roth IRA, you may have to turn to taxable investments. This isn’t a great option, but still better than the next. If you have to sell when you’re investments are down, you’re not doing yourself a favor down the road. You may get some tax benefits in this case, but you’ll have to determine whether it’s worthwhile. If you sell your investments while they’re higher than they were when purchased, you will owe taxes, which could be just as troubling in the short term if you’re still in an emergency condition. Either way, you’ll also contend with transaction fees.

Stay away from granting yourself a loan from your 401(k). If you lose your job during this emergency, your 401(k) loan will become due immediately. That’s an unaccessible level of risk, at least for me.

4. Credit. This is a slippery slope. Some recommend using a home equity line of credit as an emergency fund but having a HELOC in the first place means having an interest expense every month. The purpose of a HELOC goes beyond emergency funds, and therefore shouldn’t be the only part of an Emergency Plan.

Credit cards should be avoided in most cases. They could be used most effectively when you know that the emergency condition will subside before your credit bill comes due. Interest charged for credit card accounts is usually way too high for effective emergency use. If you have a special promotion with your credit card, like 0% APR on purchases or cash advances, then taking advantage of these deals could pay off. It requires extra special attention to make sure you don’t fall into any of the credit card traps. If you end up owing back interest due to a late payment, even in an emergency situation, you could be paying for this emergency longer than you would otherwise.

5. Friends and family. While I originally thought this fifth component is outside of one’s control, if you’ve done a good job of taking care of the universe around you, the universe will return the favor when you’re in need. If you’ve made a habit of helping those in need when you were able, when you’re in need, perhaps someone will be there to look out for you. Perhaps this will be in the form of your roommate or friend lending money to you at a very low rate or a gift from your parents. Either way, it’s best not to rely on help from the universe, as there are no guarantees. When you save cash in a money market fund, it’s guaranteed to be there when you need it. Friends and family can provide powerful assistance, but if you don’t need it, don’t take it.

Here’s a secret. There are actually six components.

6. Reduce your expenses. One thing you can do to make your Emergency Fund last longer, or save more for next time, is reduce your expenses temporarily. Make some sacrifices, like the Expensive Coffee-Relate Drink, cable television, or weekly dining engagements. Desperate times call for desperate measures. Feel free to indulge again once you find a new job or otherwise increase your cash flow to normal conditions.

What is your Emergency Plan? Do you consider yourself covered with cash in a savings account, or do you take a more complete approach?

Image credits: tanakawho, ChicagoEye