It is common knowledge that an emergency fund is a part of a healthy personal finance situation. Yet, so many people don’t actually put money aside for unexpected financial challenges.
Why do you need an emergency fund?
Sinking in debt often starts with high-cost loans in emergency situations. If you have several hundreds of dollars in your rainy-day reserve, it can be a good buffer.
At first, the need to put away money (and therefore, cutting your expenses) may seem like punishment. It may be not that easy to work out a habit of saving. However, as soon as you have some money for a rainy day, you will discover that it gives you peace of mind. You won’t have to panic if your car needs repair, if you get fired or need to replace a broken window.
How much is enough?
Most experts recommend that you have money to live on up to 8 months. If you’re single, money for 4 months’ essential outgoings may be enough, while having a spouse and kids to support require a better emergency buffer.
Also, keep in mind that you don’t need to replace your entire income; you just need to cover expenses like mortgage, food, heating bills. This means you won’t have to fund luxuries like vacations or dining out.
Create a plan
If you have a savings plan, you are 50% more likely to succeed. Once you’ve figured out how much you need to save, set up a weekly or a monthly goal. Wise financial management can provide security and promote family well-being.
Many people just can’t get started because the goal seems enormous. If that’s the case with you, try setting the initial target low. Make sure it isn’t unreachable. Let it be just $500. This amount often makes a huge difference in case of emergency. Once you’ve reached this aim, you will go on saving to create a more significant reserve.
How to stick to the plan?
Saving for emergencies should feel like a bill-pay transaction. You may opt for an automatic monthly transfer, just as with heating bills, for instance. Ideally, it should be done on the same day of every month. Remember, saving $4 a day adds up to $1,460 over a year.
Having created a sufficient emergency fund, you will be sorely tempted to spend it on something different, like a trip or fancy clothes. Try not to even check a balance until there’s an actual emergency.
Where to keep the savings?
Choose an easily acceptable place, but make sure you won’t be tempted to make withdrawals when it’s not actually necessary. You need a psychological wall between yourself and your reserve.
In most cases, a savings account will do. Yet, it doesn’t earn you too much in interest. In addition to this, if it sits with the rest of the money, it won’t be too easy to resist the temptation to tap into it.
Here’re some of the possibilities:
- create an account away from your usual checking account
- money market funds. These are not FDIC-insured and involve more risk than most saving accounts, but earn more in interest. On the whole, money market funds are far from being a risky option
- certificates of deposit can provide even better rates, yet they have a drawback: you typically have to pay if you withdraw money before the certificate of deposit matures. It makes sense to opt for CDs with three- or six-month terms
- credit unions (as they typically let you begin with a comparatively small amount of money)
Probably the most beneficial option is using several locations at once, including a lockbox at home.