Saving might not be the biggest priority when you are living pay check to check, but unfortunately, emergencies do happen. Preparing for life’s emergencies can prevent you from going into debt and creating financial chaos. Here are some tips for building an emergency fund.
Emergency Fund: What Is It and Where Do I Start?
Unexpected emergencies happen. A broken water heater floods your basement. An illness leads to a pileup of medical bills. Your car’s transmission goes kaput. If unfortunate events such as these occur, how financially prepared are you?
A recent Center for Financial Services Innovation report shows that 45 percent of Americans lack the savings needed to cover at least three months of living expenses. And while saving and putting several months’ worth of living expenses into an emergency fund seems intimidating – even impossible since your cash is accounted for each month – it can be done.
An emergency fund provides the security of knowing you can cover unexpected expenses when they arise. Plus, can help shield you from the high cost of borrowing and prevent you from hydroplaning into debt.
What Is An Emergency Fund?
An emergency fund is exactly what it sounds like: Money set aside to cover life’s unexpected events.
A key advantage to having an emergency fund is the peace of mind knowing that if or when an unexpected financial event happens, you can deal with the event head-on rather than worrying about how you will survive financially.
Short-term and long-term emergency funds play slightly different roles.
A short-term emergency fund exists for an immediate financial emergency. It should be an easily accessible account that will likely bear little interest. Short-term accounts are generally for smaller-scale emergencies, such as repairing a car or replacing a major appliance. For more extreme financial hits, it can act as a bridge to get you through a few days until you can access your long-term emergency account.
A long-term emergency account is for larger-scale emergencies, such as a job loss or house fire caused by a natural disaster. This account should earn more interest while still being accessible. Therefore, it’s fine to choose investments that could take a few days to liquidate – as long as your short-term account can tide you over.
Where Do I Start?
Starting small is a big first step. Aim for a fund of at least $500 to $1,500. Although this may sound daunting, putting $10 into your account each week will net $520 in one year – likely enough to cover a repair bill or emergency travel.
By setting a reasonable financial goal, you can feel a sense of accomplishment once you reach it. And you can gain momentum to save more money rather than reverting to paying off the debt incurred by minor emergencies.
5 Tips for Starting an Emergency Fund
To start an emergency fund, consider the following:
- Set your emergency savings goal. Assess your finances, so you know how much you’re able to put into your emergency fund. Start by estimating the least amount of money you need to live month to month – your baseline – and then determine how much you can put into your savings. Financial planners suggest your emergency fund covers a minimum of three to six months of expenses. After setting your monthly savings goal, pay your savings first rather than waiting to see what money is leftover. Out of sight, out of mind.
- Determine the best type of account for your emergency fund. Choices include a safety net fund, high-yield savings account, money market account, certificate of deposit or treasury bills account. If unsure, consider talking to a financial advisor. Whatever you choose, make sure your emergency fund and checking accounts are separate, so you aren’t tempted to dip into the emergency fund.
- Set it and forget it. By setting up an automatic transfer from your checking to your emergency savings account, you won’t forget to put the money aside and won’t be tempted to spend it, either.
- Consider Eliminating at least one frivolous spend. Since every dollar helps, consider eliminating at least one non-essential purchase. Cook a meal rather than going out to eat, do away with your daily latte or put an expensive hobby on hold.
- Assess and adjust contributions. Keep tabs on how much you’re saving by checking your balance after a few months. If adjustments are needed, then make them – just try not to decrease your contributions. Since budgeting is an important life skill, you’ll be thankful you’ve set funds aside if an emergency occurs.
Watch Your Money Grow
As its name implies, an emergency fund is for emergencies only – not for planned purchases such as a new car, house or education. And when it comes to saving, draw the line between emergencies and everything else and don’t stop contributing. Instead, steadily add to your emergency fund until you can cover expenses for half a year.
Money doesn’t grow on trees – but it will grow in your bank account if you start small and keep on adding.