Dear Dave: Are home warranties a waste of money if someone has been following your plan and already has six months of expenses set aside in an emergency fund, plus home insurance?
Dear Andrea: Home warranties are a waste of money even if you don’t have quite that much set aside in an emergency fund. I recommend an emergency fund of three to six months of expenses to cover the unexpected things that life will throw at you. This amount of cash, sitting in a good money market account with check-writing privileges, will give you easy access in the event of a financial emergency.
I don’t recommend extended warranties of any kind. They’re just not a good deal. You’re better off to self-insure against things breaking down, and putting what would have been profit and marketing dollars for the extended warranty company in your own pocket!
Dear Dave: Should I stop making contributions to my 401(k) account for a year in order to save up an emergency fund? Thanks to you, I’m 33 and debt-free.
Dear Blake: Congratulations on being debt-free at such a young age! I appreciate the credit, but the truth is I just pointed you in the right direction. You made the sacrifices and did all the hard work. I’m really proud of you!1 comment on this story
Yes, my advice is to temporarily stop making contributions to your 401(k) until you save up an emergency fund of three to six months of expenses. It shouldn’t take a year, though, to set aside an emergency fund if you’re debt-free and making decent money at your job. Just make it part of your monthly budget plan, and get that emergency fund set up in a few months.
Here’s the way I look at it. If you don’t have an emergency fund, but you’re contributing to a 401(k), there’s a good chance you’ll end up cashing out your 401(k) if something happens that leaves you with a large, unexpected bill. When you cash out a 401(k) early, you get hit with a penalty plus your tax rate. That’s not a good plan!
And that’s just one of the reasons I tell people to have an emergency fund in place before they start investing.