Emergency Funds: Why You Need One & How To Save

Emergency Funds

Put away money incase of an emergencyEmergencies happen. The entire world learned that the hard way with the coronavirus crisis.

Millions of people also learned they were not financially prepared. About 40% of Americans don’t have $400 in savings, according to the Federal Reserve.

The pandemic showed how vital it is to have an emergency fund. But how do you start one? How much do you need? Where should you put that money?

Here’s a guide to building a fund that will stand up to your next emergency.

What Is an Emergency Fund?

An emergency fund is an amount of money you set aside for an unforeseen (and expensive) dilemma. The most obvious plight these days is getting laid off from work, with the unemployment rate skyrocketing toward 20% in June 2020.

But life had plenty of financial potholes before anyone ever heard of COVID-19. Cars broke down, appliances needed replacing, medical problems popped up. That stuff will be happening long after COVID-19 fades away.

Why You Need an Emergency Fund

If you’ve been laid off and don’t have $493 in the bank, the answer to your financial problems is obvious. You need an emergency fund to survive.

You’ve still got rent to pay; food to buy; and utilities to take care of. Your car breaking down isn’t as dire, but it’ll still need fixing. Many people aren’t able to simply write a $2,000 check for a transmission repair job or similar problems. An emergency fund gives them quick access to needed cash.

Why is that important? Consider the alternatives:

  • Using a credit card: That means you’ll be paying between 15% and 25% interest on the money. In real terms, say you charge that $2,000 transmission repair on a credit card with an 18% interest rate. If you pay $50 a month, that brake job will cost you an extra $400 in interest over the next year. When emergencies hit, the last thing you want to do pay for it on credit. That just leads to a cycle of debt that gets harder to break.
  • Tapping into your retirement fund: Besides messing up your long-term finances, there are serious tax consequences when you withdraw money before a set date.
  • Dealing with anxiety: You’ll sleep better knowing you have a cash safety net when the inevitable emergency comes along.

How Much Do You Need to Save?

If you have nothing right now, aim for $1,000. Then start building until you have put aside 3-6 months worth of expenses.

By that, we mean create a budget by adding up your fixed costs like mortgage, car payment, utility bills, food. You know, the essential expenses of life. A budget will help you determine how much money you need to cover bills on a monthly basis.

The average household spends 62% of its income on such things, according to the Bureau of Labor Statistics. Don’t include non-essentials like dinner at Morton’s steakhouse or tickets to “Hamilton.”

When money is tight, it’s no time to splurge.

6 Tips to Start Saving

If you have a calculator, figuring out how much you need is easy. Figuring out how to save that amount is where the work really begins. Here are few steps to get you started:

  • Create a Budget: In order to form a plan of attack, you must first know the basics: How much money do you have coming in and where it is going? To create a budget, list your monthly income on one side of a ledger and monthly expenses on the other. Then start figuring out ways to increase the former and decrease the latter.
  • Cut Expenses: It’ll be painful, but you really can live without premium TV channels, eating out, $5 lattes from Starbucks and other luxuries. Suck it up. If roughing it means watching basic cable and eating canned spaghetti, you’re still better off than 90% of the planet. Many creditors have instituted temporary leniency programs due to the coronavirus program. Contact your credit card company, bank and other creditors to see what’s available.
  • Set A Goal: You need a dollar number to shoot for each month. That will help make saving money a habit, and habits get easier the more you do them. Goals are also motivational. Reaching them is a reward in itself, but you can also treat yourself with a trip to an ice cream shop or some other token bounty. Just don’t go crazy on the toppings.
  • Save Your Tax Refund or Stimulus Check: If you’re getting money back from the IRS or haven’t already spent your CARES Act coronavirus stimulus check, don’t spend it blindly. Putting your tax return toward an emergency fund is a great way to jump-start your savings. Even without a windfall, every little bit helps. If you just put $5 a day into an emergency fund, you’d have $1,825 in emergency money in one year.
  • Search for New Sources of Income: Sell unwanted possessions online. Look for side jobs or a better-paying fulltime one. As bad as the pandemic hurt the economy, it also created thousands of jobs in health care and home delivery services.
  • Automate Savings: If your employer offers direct deposit, have a portion of your paycheck automatically transferred into your emergency savings fund. Automating your savings is a good way to enforce your self-discipline. After a couple of pay periods pass, you probably won’t even notice that $50 or $100. Gradually increase that contribution as your comfort level grows.

Best Place to Keep an Emergency Fund

Remember, it should be a fund unto itself. Funneling emergency money into your checking account or other savings accounts makes it too easy to use in non-emergencies.

Sticking it under your mattress is also not a good idea, since your mattress does not pay interest. Investing your emergency fund in stocks, bonds or mutual funds is also not advisable. They are designed for long-term growth and their values fluctuate.

Your best options are:

High Yield Savings Account

These are bank accounts that earn you a higher interest rate than traditional savings accounts. They are easy to access and federally insured up to $250,000, so your money is safe.

Savings Account with High Interest Rate

Unlike putting your money in stocks or bonds, there’s not much risk in a savings account. There’s also not much reward.

It’s not uncommon for banks to pay 0.01% interest on savings accounts. With inflation, you might actually be losing money.

High-yield interest rates typically pay 1% to 2.2%. If your bank does not offer one, there are plenty of online banks that do.

Struggling with Saving an Emergency Fund?

About 78% of Americans are living paycheck to paycheck, according to a CareerBuilder survey. A lot of them have undoubtedly tried to save money, but those best-laid plans got lost in life’s merry-go-round.

Getting organized is the first step to getting out of debt and saving money. The good news is there’s help out there.

Nonprofit organizations like InCharge Debt Solutions offer free credit counseling to discuss your financial situation. There are strategies, like a debt management program, that find lower interest rates and consolidate your bills into one monthly payment.

That will help get you in the position to start saving for an emergency. You never know when one will hit. But sooner or later, you know one will.


Sources