For many people, an emergency fund can be the difference between being able to weather a financial storm and being forced into debt. Unexpected expenses will always come up no matter how much you plan, so having an emergency fund can help you be prepared for whatever comes your way. Here’s a beginner’s guide to saving emergency money and how you can create an emergency fund:
What are emergency funds?
An emergency fund is a savings account that you can use to cover unexpected costs, like unemployment, medical bills, or car repairs. The account is typically funded with three to six months of living expenses so you can cover expenses if you ever experience a financial setback.
Why are emergency funds important?
Emergency funds are essential because they help you cover sudden expenses without going into debt. Having an emergency fund can also help you avoid high interest rates, overdraft fees, and late fees.
A well-padded emergency fund can allow you to relax because you have a financial cushion to fall back on in case of an emergency. If you get an unexpected medical or car repair bill, you’ll have the funds to cover it. And if you lose your job, an emergency fund can help you keep up with your monthly bills and groceries until you find employment.
How to create an emergency fund
Here are the steps you can take to create an emergency fund:
Figure out how much you need to save
A good rule of thumb is to have three to six months’ worth of living expenses in your emergency fund, but you can also start with a smaller goal of $1,000 or whatever amount you’re comfortable with to kick things off. Once you know how much you need to save, you can start setting aside money each month with every paycheck.
Find out how much you can afford to save every month
After you’ve created a savings goal, you’ll need to figure out how much you can afford to put aside each month. Find out how much your after-tax income is and add up your monthly expenses like housing, food, transportation, healthcare, debt payments, utilities, and insurance. Don’t forget to include any discretionary expenses, like entertainment, personal care, and gifts.
Once you have your monthly after-tax income and monthly expenses, you can subtract your monthly expenses from your monthly after-tax income to determine the amount you can afford to save each month.
Automate your savings
Automating your savings can make things effortless. Here’s a few ways to automate your savings:
- Direct deposit: Set up a direct deposit from your paycheck into your savings account so you won’t even see the money, and you’ll be less likely to spend it.
- Budgeting app: Use a budgeting app or service that automatically deducts money from your checking account and transfers it into your savings account. This can be a set amount each month or a percentage of your income.
- Automatic transfer from checking: Set up automatic transfers from your checking to your savings account so you’ll never forget, and you can easily track your progress. Start small and increase your savings over time to reach your financial goals.
Make your emergency funds difficult to access
The easier it is to access your savings, the easier it will be to spend it. Consider keeping your emergency fund in a separate account that is not easily accessible to help you avoid dipping into it for non-emergencies. You can also get a savings account with a completely different bank, making it harder to transfer funds. This will force you to think twice before spending your savings and help you to save more money in the long run.
Review and adjust
Your emergency fund should change as your financial situation changes. Review it periodically to make sure it still meets your needs. You can do this by checking your account balance often, evaluating your spending habits, and frequently reviewing your financial goals.
The bottom line
If you have a financial emergency, the last thing you want to worry about is how you’re going to pay for it. With an emergency fund in place, you can rest assured that you have the resources you need to get through tough times. Ensure that you create realistic and attainable savings goals to keep your emergency fund healthy and growing.
Notice: Information provided in this article is for information purposes only. Consult your financial advisor about your financial circumstances.