An emergency fund is a safety net that cushions you when you are faced with sudden occurrences and unexpected events. This should be one of your greatest financial goals even if you don’t have the cash in crisis right now. If you don’t have an emergency fund, you are not alone as a recent study in the US demonstrated that 21% of the respondents don’t have emergency funds set up.
Having enough money saved on your emergency fund helps to recover your spending faster and get back on to your saving goals.
This article contains a step by step guide on how you can set up an emergency fund.
What is an Emergency Fund?
Emergency funds are regarded as fundamental elements to solid financial plans. These funds allow you to cover any unexpected expenses without having to to take out any high-interest credit cards or payday loans.
Why are emergency funds so important?
Evidence suggests that individuals struggling to recover from financial emergencies or unexpected events have less saved. Most people may rely on credit card or mortgage payments resulting in debt which is hard to pay. For someone who lives alone a significant monetary shock could happen to them without saving and when it reaches debt can have long-term effects.
Some of the common events that you can address using your emergency funds include:
- Unemployment or Job Redundancy
- Unexpected medical emergencies
- Increased living expense.
- Emergency home repair.
- Unexpected auto repair.
How much should I save?
A common question is how much should an emergency fund be?
An emergency fund should have enough money to cover expenses of 3 to 6 months. The savings can take time for many people. Start off with some small goals like a savings fund $1,000 before working it until it’s a reserve to pay for a month or two. Your specific savings goals depend on your income and costs. A breadwinner, a businessperson or a person with an exceptionally volatile income may want to aim for at least nine months of expense in an emergency savings account.
Where should I keep my emergency fund?
It is often advisable to keep an emergency money supply in an area that has liquidity that is easy to reach and easy to keep. As such, it is recommended that you should keep your emergency fund in a high-yield savings account. These type of savings accounts offer its users instantaneous access that comes with high and competitive yields. You should also look for banks and credit unions which will certify your deposits with the FDIC or the NCUSIS. Online banks have usually higher yields than physical bank. Putting your cash in a checking account is another option though most will not pay interest.
How to start an Emergency Fund
The steps below detail how to start an emergency fund and stick to it.
Step 1: Make a budget and see where you can start saving more money
Without budgeting your finances you’re not able to use maximum income and find ways that reduce or limit your spending. You can create a budget using our article on How to Track Expenses in 4 Easy Steps and Never Fail at Budgeting Again. This article details how you will be able to calculate your spending and earning so you can get a quick view of what your finances actually are. Creating a budget is integral in determining which recurring expenses you have and if it is possible to add your savings for the emergency fund to the identified expense category.
Step 2: Determine how much money you need saved for emergencies
A general guideline is keeping three to six months worth of expenses safe in your contingency. Some financial experts talk about having an emergency fund for just $1,000. However, this amount varies depending on your needs and income. For instance, you might want to save more money on food until you have paid someone off or find a new job when you need one. Other people may be more comfortable and stable with their income or have access to home equity or other forms of credit that may be used during an emergency and may budget for a lower emergency fund. You could also factor in the previous cost of unexpected expenses towards your savings goal. For instance, if you had a medical emergency and it cost you $300 to resolve then you can use this figure as a baseline. However, always keep in mind that your emergency fund should be able to cover three to six months of expenses.
Hint: It is important that you should not over save! By definition a crisis fund is money available within minutes. It means you could store it in a low-yield account such as savings accounts with very low interest rates. For that reason only you shouldn’t contribute until you reached the end of the target period. Over saving will only contribute to more debt and will financially strain you.
Step 3: Find Where you’ll keep your emergency fund
You should begin conducting your research on the account that best suits your needs for an emergency fund. A good account is easily accessible during an emergency but not too accessible that you can withdraw to meet some expenses. Other important characteristics include having a yield on your savings and being secured by State and National financial agencies. Once you have selected where you will save your money, then you can begin saving. A checking account could also be used but it often doesn’t come with the expected yield. You can also look at other financial products and services like the money market which offers a relative stable yield and low risk. However, such accounts come with investment risk that you should be aware of.
Hint: Automate your savings! Automatic transfers are a good way to keep recurring savings. The most efficient way to save more and comply with your savings goal is to never even touch it from your income. Create a separate account only for an emergency fund and pay a contribution by selecting its contribution amounts. Direct deposit scheme can also be used as a way of automatic savings. Instruct the saving institution to automatically deduct the money from your income before you can access it. This can be done with your selected bank and you should ask if they offer automatic deductions. To help you stay more alert make sure you set up automatic notifications or reminder for checking your balance.
Step 4: Start with small, regular contributions
Set an initial contribution rate of low amount. This ensures that you don’t worry about your own balance and makes it easier to rationalize contributing it your current savings habits. To succeed, you must ensure that you make the saving a habit and not a constant battle.
Step 5: Balancing debt and your emergency fund
Be able to balance your desire to keep a savings account and your urge to get out of debt. Staying out of debt is integral in managing you emergency fund. Most people often used their emergency funds to settle debts and this should not be the case. You should also include your debt as a recurring expense in your budget and service them constantly. If you retire, you can increase your emergency fund and the goal can be achieved of creating a safety net that exist out of debt and retirement funds. Having a small cushion is better than a total cushion even when you’re in debt.
Step 6: Regularly monitor your progress
You should develop a system of monitoring your savings to ensure that you are on the right path. Some approaches to monitoring your account and progress includes enabling automatic notifications of your account balances or using printable account balances planner or budget sheet where you note down every monthly contribution and the running balance. This is a good way of motivating yourself and helping you achieve your goals.
Step 7: Stick to your plan
Once you have finished creating your emergency fund plan and have made the first contribution then stick to it. Building an emergency fund requires dedication and commitment to the outcome. As such, you should make sure that you are able to comply with the goals that you set for yourself. This fund should only be used on unexpected expenses and not other expenses. Your savings account and emergency savings will help you become more financially stable. You should also exploit any tax refund or credit that comes with your savings goals in your state.
Step 8: Celebrate your Success
It is important that you celebrate your ability to save months worth of expenses. This is a cushion that many people do not have and will be integral in securing your future. The ability to fund an emergency without loans is something one should aspire for and be proud of. Celebrating your success is also a means of motivating your towards achieving your personal finance goals and ensuring that you save money in case of income disruptions.
An emergency fund gives you the peace of mind that you have set aside enough money to meet your monthly expenses in case of unexpected income or job events. This is like a personal insurance fund that will always pay you during your emergency. It is a paycheck from your current self to your future self, and nothing will make you more motivated in meeting your personal finance goals than having a plan that guarantees your future financial stability. Securing your living expenses is integral in securing your financial future.