Why you need an emergency fund
"Extra" money can be hard to come by these days. And when you do find a little extra in your budget (or pocket), one of the hardest things to do can be to set it aside just in case you need it later.
However, building an emergency fund is one of the smartest things you can do with your money. Most people should aspire to save enough to cover six-nine months of living expenses. This is not necessarily the same amount as your salary. It means enough money to pay the necessities: rent or mortgage, car payment, utilities and groceries. As the name suggests, an emergency fund will help see you through an unexpected and potentially costly life event, such as a health crisis, a job layoff or a major home repair. Unfortunately, almost a third of Americans have no cash saved in reserves for an emergency.
Yet it is never too late to start saving. These tips can get you started.
1. Start off small. The idea of stashing several months' living expenses may sound too ambitious. Exactly how much to save depends on your situation. Take a look at your income and your expenses to determine an amount that you can comfortably save. Then, treat that monthly savings goal as a bill and make paying it a part of your regular budget. Every little bit helps. If you can set aside $25 a week, you will save $100 by month's end. At the end of the year, you will have saved more than $1,000.
2. Decide how to save. Emergencies, of course, happen unexpectedly. This is why it is important that your emergency fund be easily accessible (within one or two business days). Consider a traditional savings account or money market account. Both allow you to earn some interest while saving. After your savings has grown to a more sizable amount, you might consider investing the money in something that pays better interest, like a bond or a short-term certificate of deposit. But remember that it's important not to take much risk with these funds, and that quick access is important.
3. Bank your windfalls. It is a good feeling to pay off a car loan or credit card bill, or to get a tax refund. When one of these things happen, instead of spending the "extra" money, use it to grow your emergency fund. That $300 per month, for example, that previously went toward a car payment can now go directly into emergency savings.
4. Balance debt repayment and savings. Many people find it difficult to save for an emergency fund because they are trying to pay off high debt loads. Putting most of your money toward debt makes good financial sense. But if you look carefully at your expenses, you may identify steps you can take -- like pack your lunch instead of buying it -- that will free up some cash. Put these savings into your emergency fund. Of course, you also need to stop adding to your debt. Avoid making any charges that you cannot pay off in full each month. Also, be sure you are not spending frivolously with credit cards -- studies have shown people spend more with plastic. In particular, if you are trying to pay down debt and also start saving, using cash or a debit card instead of a credit card will help you reach your goals.
5. Fight temptation. You will be less likely to miss money that you do not see. Set up an automatic transfer from your primary checking account to a savings account on the same day that your paycheck is deposited. Some people prefer to put their savings into an account completely separate from their normal checking account. An online bank is one option to consider, too. Another trick is to never carry a debit card that is tied to the emergency account.
When finances are tight, an emergency fund may seem like a luxury. It is not. The truth is that when emergencies hit, you will find that you cannot afford not to have one. Not having saved for a crisis is what throws many people into a financial disaster. Saving for a rainy day -- as your grandparents may once have suggested -- makes good financial sense.