How to create an emergency fund – Forbes Advisor
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Unexpected expenses can mess up your financial plans, especially if you don’t have the cash on hand to cover them. According to the Federal Reserve’s most recent household welfare analysis, 36% of Americans say they would not be able to cover a $ 400 emergency in cash.
The Covid-19 pandemic has underscored how important it is to have savings in the event of layoff or job loss, or prolonged illness that prevents you from working. And even if you haven’t been affected by job loss or illness, life could throw you another financial curve.
But what if you start with $ 0 in savings? If you’re ready to start an emergency fund, this guide can help.
What is an emergency fund?
An emergency fund or a rainy day fund is money that you set aside to cover unforeseen expenses or financial emergencies. For example, you can use your emergency fund to pay for things like:
- Home repairs needed, such as a leaky roof or broken HVAC system
- Unscheduled car repairs
- Medical bills for unexpected illness or injury
- Monthly expenses if you lose your job
- Unexpected veterinary bills
An emergency fund is not designed for non-essential expenses. In other words, you wouldn’t be using that money to take a vacation or buy new clothes. Instead, you would keep that money in reserve in case a situation arose where you really needed the extra funds.
How much money should you have in an emergency fund?
When deciding how much to save for emergencies, there are rules of thumb often recommended by financial experts.
For example, you might have heard that it’s okay to start with saving a minimal emergency fund, maybe starting with $ 1,000. That’s enough money to cover any minor emergencies that might arise. From there, you can save up to three to six months of living expenses, or even more, depending on your needs and goals.
The three to six month benchmark is a good place to start; however, this is not a foolproof rule. The Covid-19 pandemic has illustrated how having even six months of emergency savings may not be enough if you experience a prolonged decline in your income. A Harvard University survey found that 48% of households that suffered job loss as a result of the pandemic used all or most of their emergency savings as a result.
When deciding how much to save in an emergency fund, consider the following:
- The number of people in your household
- The number of people in your household with income
- The minimum amount you would need to cover your monthly expenses
- The stability of your different sources of income
The size of your emergency fund should reflect a realistic amount, based on how much you can afford to save, and an amount that you feel comfortable with.
For example, instead of following the three to six month spending rule, you could aim for nine to 12 months instead. Or you can choose to save a fixed amount, like $ 2,000 or $ 5,000, for each person in your household. Once you’ve decided on how much you want to save for emergencies, you can move on to the next step.
Find money to save in an emergency
If you are ready to create your emergency fund, you will need to find the money to save. The first step is to review your budget.
As you go over budget, separate your essentials from non-essentials. On the essential side, there are things like rent or mortgage payments, utilities, and food. On the non-essential side, you can have things like clothing, entertainment, and restaurant meals.
Go through the list of things you normally spend money on that don’t meet actual needs and think about what you can reduce or eliminate. If you’re struggling to find the money to save, you may need to look at your income.
Specifically, think about ways to make more money each month. This may include taking overtime at work, getting a part-time job, or starting a sideline. Even selling things around the house that you no longer need can help. The more money you can contribute, the more you can add to your emergency savings.
The next steps in creating an emergency fund are relatively straightforward. But following them can help you grow your savings on rainy days with minimal headaches:
- Automate your savings. Setting up automatic check-to-savings transfers every payday, or sending a portion of your paycheck to savings through direct deposit, eliminates the temptation to spend money. extra money in your budget.
- Save the deals. Receiving tax refunds, economic impact payments, rebates, and other unexpected financial benefits can be a boon to your savings goals if you put them in your emergency fund, rather than spending them.
- Get cash back to save. Cash back apps can reimburse you for a percentage of what you spend on purchases, meals, and other purchases. Signing up for one or more cashback apps and then depositing the money you earn into savings can help build your emergency fund.
- Check your withholding tax. If you usually get a refund at tax time, it may be because your employer is withholding your paycheques too much. Adjusting your withholding tax can put more money back into your paychecks, which you could then use to grow your emergency fund throughout the year.
But what if you’ve followed all of these steps and you’re still struggling to find the money to save in an emergency? If you are overwhelmed with debt or having trouble keeping your budget under control, you may want to consider speaking with a certified credit counselor. The National Foundation for Credit Counseling is a good place to start: Nonprofit credit counselors can look at your financial situation and help you develop a realistic game plan for creating an emergency fund.
Where to keep your emergency fund
Once you have a plan for how much to save for emergencies, it’s important to figure out where you’ll keep your emergency savings. Ideally, your emergency fund should be in an easily accessible, interest-earning account. However, the amount of interest you can earn is less important than having your emergency savings readily available and risk-free in the market.
High yield savings accounts are a good option because they can offer competitive interest rates and have lower fees when offered by online banks. Additionally, you can link your high yield savings account to your checking account to make it easier to transfer funds between them.
Emergency Fund Frequently Asked Questions (FAQ)
Why do i need an emergency fund?
There’s a simple reason you need an emergency fund: to avoid getting into debt.
If an unexpected expense arises and you don’t have the savings to cover it, your only options for paying it might be to charge it to a credit card or get a loan. You’ve covered the emergency, but now you have debt to pay off, which can come with a high interest rate.
Having an emergency fund makes it easier to avoid debt and the high interest charges that can arise.
Is an emergency fund of $ 1,000 sufficient?
Saving $ 1,000 for emergencies is a good place to start, and it’s better to have something in savings than nothing at all. But a $ 1,000 emergency fund will go no further.
When thinking about how much to save in an emergency fund, consider different scenarios in which you might need the money. These include job loss, injury, illness, or anything else that could deviate your budget or income. Then use it as a guide to determine how much to save.
How much should I put in my emergency fund per month?
The amount you save in your emergency fund each month may depend on your savings goal. For example, suppose you want to save $ 10,000 for emergencies next year. You would need to save around $ 833 per month to reach your goal.
If you already know how much you want to save and how long you want to give yourself to reach that amount, finding a monthly savings goal is easy. Just divide the dollar amount by the number of months to figure out how much to save for an emergency each month.
Should I use my emergency fund to pay off my debts?
Emergency funds are designed to be used only in an emergency. But if you’re struggling with high-interest debt, you might be wondering if it makes sense to dip into your savings to pay off some of them.
On the one hand, it could save you money on interest charges. And if you can manage to get rid of your debts and free up more money in your budget, it may not take long for you to replenish your emergency fund.
But think about how much of your emergency savings you’ll need to use up, and how soon you could replace them. If an unforeseen cost arises right after you exhaust your emergency fund to pay off debt, you could end up having to go into debt to cover it.