Are you living paycheck-to-paycheck? Do money problems keep you up at night?
If you answered yes to either of these questions, you are not alone. According to CareerBuilder, 8 out of 10 people live paycheck-to-paycheck. This can cause huge financial stress and debt if an unexpected expense comes along – and it will.
The best way to feel better about your financial situation and to guard against unexpected expenses is to have an emergency fund.
What Is An Emergency Fund?
An emergency fund is a sum of money you’ve set aside to cover large, unexpected expenses. It acts as a buffer between your income and any financial surprises that come your way.
When Should I Dip Into My Emergency Fund?
It is important to know that emergency funds are not slush funds. The money in your emergency fund should only be used in true emergencies. Before dipping in, make sure the situation calls for it.
Correct Uses for an emergency fund include:
- Car trouble
- Job Loss
- Medical bill
- Leaky roof
- Dental emergency
- Appliance repair
Incorrect uses for an emergency fund include:
- New shoes
- Birthday dinner
- Flash sale
- Upgrading appliances
- Christmas gifts
Not every situation is black and white. Sometimes it can be difficult to know for certain whether dipping into your emergency fund is justified. Use your best judgment here.
Why Do You Need An Emergency Fund?
You never know what life will throw your way, so it is always better to be overprepared and overfunded. Having an emergency fund in place comes with a lot of benefits.
- Reduced stress. Money may not buy happiness, but it can buy serenity. Simply having an emergency fund will grant you peace of mind. You will be able to rest easy at night knowing you have a financial safety net.
- Less impulse spending. If you keep all of your money in one account it is very easy to think that you have excess funds and to blow that excess on “for fun” items. Setting your emergency money aside, into its own account, is the best way to prevent this frivolous spending.
- Fewer poor financial decisions. When you are put in a difficult financial situation you may be desperate to dig yourself out. This desperation often leads to poor decisions such as putting all the money on a credit card, taking out an unsecured loan, borrowing from friends or family, withdrawing from your retirement account or selling your investments – all of which will hurt you in the long run.
An emergency fund prevents these desperate moves, allowing you to maintain your financial health.
How Much Money Should Be In Your Emergency Fund?
Most financial experts recommend having between 3 and 6 months’ worth of expenses in your emergency fund. First, you need to determine how many months’ worth of savings is right for your household.
Choosing An Amount That Is Right For You
The amount of money you need to set aside will vary greatly depending on your situation.
If you are in a stable, dual-income household you may be able to get away with just 3 months’ worth of savings. However, if you are a one-income household, work in a high-risk industry, are self-employed, work on commission or someone in your household has a chronic medical condition, then you should aim for the six-month fund.
Once you’ve decided how many months’ of funds you want to cover, the next step is to determine an exact figure.
Calculating Your Expenses
To get a number for your emergency fund, you first need to determine one month’s expenses.
Review past expenditures to see how much money you spend in an average month. Be sure to include costs for housing, food, healthcare, insurance, utilities, transportation, personal expenses and debt.
Pro tip: the easiest way to get a quick snapshot of your spending is to sign up for a free Personal Capital account. Once you link your credit cards and bank accounts, it’ll give you a complete breakdown of what you spend your money on.
Once you’ve determined how much one month’s worth of expenses is, simply multiply that figure by the number of months you wish to save for.
If you are currently in debt, building an emergency fund may seem extremely overwhelming.
The important thing is to have something set aside, even if it is small. Focus on setting aside $1,000 as your emergency fund. Once you’ve accomplished that, redirect your efforts into getting out of debt. Return to growing your emergency fund once you are entirely debt-free.
How Do You Build An Emergency Fund?
As most people do not have the means to create and fill their fund in one go, building an emergency fund is a process. It is often done through a series of small deposits over a long period of time.
Set Savings Goals
Once you have an end goal in mind, it’s easy to figure out how to get there. Determine how much you can reasonably set aside each month for your emergency fund and then calculate how many months it will take you to reach your target amount based on that monthly contribution. Write these goals down and stick with them.
Automate Your Deposits
The easiest way to save money is if you never have the option to spend it. Setup automatic deposits or automatic transfers so that your monthly contribution remains steady and timely.
Trim Your Budget
Most, if not all, households waste money. However, it is highly possible that you are wasting way more money than you realize. Check your budget for money leaks such as running the A/C too low or splurging on expensive bottles of wine, and plug them. Use those savings to increase your monthly contributions to your emergency fund!
Trim is a sweet tool that helps you find subscriptions that you no longer need. It also negotiates a lower rate for your monthly bills.
Your financial situation is bound to change as your income and expenses fluctuate. Every few months you should go into your accounts and check to see how much you are saving and spending. Adjust your monthly contribution as needed.
What Are Some Tips For Building An Emergency Fund?
If you stick to a regular schedule with your deposits, you will meet your savings goal. However, this will likely take longer than you want and it may be difficult. If you want to speed up and simplify your savings process, keep reading.
Jumpstart Your Emergency Fund By Selling Your Junk
You can quickly build a strong foundation for your emergency fund by selling belongings you no longer use. Look through your home for items you can easily part with and sell them online (spot for potential affiliate link?) or in a garage sale. One very successful method is to sell your old clothes. Whatever you decide to get rid of, every bit will help.
Keep The Change
Chances are you have a lot of spare change lying around. Whether it’s in the cup holders of your car, on the top of your dresser or at the bottom of your purse, gather it up and put it in a jar. Every few months total up the money in your change jar and add it to your emergency fund for a good boost. If you don’t carry change, collect your virtual change with these savings apps.
Saving money is hard, especially when the world is full of temptations to splurge. Every once in awhile, when you meet a savings milestone, feel free to give in to those temptations by rewarding yourself with a small, inexpensive treat. This will refresh your savings spirit and help motivate you to continue toward your goal.
Add A Supplemental Income
There is no better way to save money than to have multiple income streams. Even if it is only an extra $200 a month, it will have a huge impact on your financial health. Learn more about how to generate a second (or third or fourth) income here.
Save Your Tax Refund
People love to splurge with their tax refunds, viewing them as “free money”. But the truth is that tax refund is simply your hard-earned money being returned to you. Don’t waste it. Instead, put it towards your emergency fund and a better financial life.
Where Should You Keep Your Emergency Fund?
Knowing where to put your emergency fund can be tricky as it is a large sum of money that you will want to keep both protected and handy.
When trying to decide where to keep your emergency fund you’ll want to look for an account that is:
- Low-risk. You need to know that your money will still be there when an emergency strikes. Therefore, it is important to keep your emergency fund in an account or investment that is safe from market risk.
- Liquid. Liquidity describes the degree to which an asset can be quickly converted into cash with little to no penalty. When you are faced with an emergency, you often don’t have time to waste. You’ll want to be able to get to your funds quickly and without penalty, so you’ll need to save them in the form of liquid assets.
- Accessible. You want your funds to be accessible so that you can quickly use them when you need to. However, you don’t want your funds to be so easily accessed that you are tempted to dig into them for non-emergencies. Think bank account versus dresser drawer.
- Interest-bearing. While the point of an emergency fund is to serve as a safety net and not to make money, you should never let a large sum like this go to waste. Look for opportunities to earn interest on your savings, however small that interest may be.
I recommend looking for a high-yield savings account. They are federally insured for up to $250,000, so it is low-risk. There are usually no penalties for withdrawing your money, so it is liquid.
You can easily transfer money from a savings account to a checking account. Most checking accounts come with a debit card or check-writing privileges, so it is accessible. And they often offer interest rates of around 1.75% APY, so it is interest-bearing.
I highly recommend checking out CITBank’s high-yield savings account.
Also read: What is a medium-term goal?