6 Simple ways to build an emergency fund
When people talk about personal finance the second thing people suggest is having an emergency fund. It is a great thing to have but creating one can feel daunting. There seem to be so many different rules and recommended amounts. To clear this up for you we are going to talk about why you need an emergency fund and how you can fund it.
What is an emergency fund?
According to Wikipedia, an emergency fund is “a personal budget set aside as a financial safety net for future mishaps or unexpected expenses”. This definition clearly identifies this fund as a personal financial safety net. The money in this account is not where you come when your favorite bank goes on tour or a great deal on a last-minute vacation pops up. This account is for true emergencies like car/home repairs, medical bills, job loss, or other family emergencies having money set aside can help you weather these storms with less stress.
Why you need an emergency fund
Because life is unpredictable you never know when you may get a flat tire or your dishwasher dies. According to a recent survey, nearly 70% of the people polled have less than a thousand dollars saved. Creating a savings fund will help you when, not if, life gets expensive and will reduce your dependency on credit cards or expensive short-term loans.
How to start an emergency fund
Create a budget: If you haven’t already created a spending plan so that you know how much money you have coming in and going out each month. Once you have this information you will be able to see what your monthly expenses are so that you are better able to create your emergency fund savings goal.
Set a savings goal: Create a clear definition of what constitutes an emergency for you. This creates a clear intention and boundary for your fund moving forward. It is recommended that you have 3-6 months of your living expenses saved for emergencies. For many people, this could be between $4,000 and $25,000. If you are like the 70% of people who stated that they don’t have a thousand dollars saved this figure can be paralyzing. For this reason, I recommend setting your goals in one thousand dollar increments until you reach one month of expenses then building from there.
Calculate how much you need to save to reach your goal: Once you have settled on your savings goal amount now you get to start saving for it. Break your total down by month then divide that by the number of paychecks you have each month. For example, if one month of expenses is $5,000 and you want to have that saved in the next 5 months that would be $1,000 each month or $500 every two weeks. There are a lot of savings calculators out there but this one by the Consumer Financial Protection Bureau is my favorite. So, if you don’t want to do the math yourself give that one a try.
Open a dedicated account to hold the funds: Open a dedicated savings account for your emergency fund. I recommend using a high yield savings account for this type of fund since this account will typically grow to high five figures or more you want to maximize the benefit of compound interest in your favor. One bit of personal finance advice that I disagree with is making this account hard to access. In the event of a true emergency, you don’t want to have to wait 3-5 business days to have your funds. To avoid this, make sure that the account that you open has a checking account with a debit card attached so that you can easily transfer the funds and then seamlessly use it to pay for the tow truck and rental car if needed.
Automate savings: To maximize your savings automate the savings process. You can do this through payroll deposits or automatic transfers between your accounts. Using this set it and forget it approach removes the temptation to spend the money instead of saving it.
Don’t touch it: As your account grows it can be tempting to spend this money on other things. In order to avoid this, consider using a savings tracker that you can complete. Put it somewhere you can easily see it to stay the course.
When to use it (true emergencies)
Spoiler alert: a flash sale or concert does not constitute an emergency. It may seem silly to say but I have had clients who routinely dipped into their emergency funds for these types of expenses. Job loss, a late-night vet visit, or a broken leg are a few events that constitute a true emergency.
Save even when you have debt
There are some people in the personal finance space who believe that you should not save more than $1,000 if you have debt. I disagree with this low savings bar because things like major car repairs or job loss require more than a thousand dollars. Failing to build a larger nest egg can lead to maxed-out credit cards or overpriced short-term loans.
Prepare for the unexpected
One of my favorite quotes is “Life happens while we are busy making plans”. This is incredibly true when it comes to our finances. Creating a savings cushion provides peace of mind so that when life happens, we can focus our energy on resolving the issue rather than paying for it.