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How To Start An Emergency Fund & Why You Need One



Emergency fund

It’s often hard to think about starting an emergency fund. Many people, and many families, are having a hard enough time making it by as it is. According to the Federal Reserve, 40% of Americans don’t have enough saved to cover a $400 emergency. Another Bankrate survey conducted in 2018 revealed only 39% of Americans have enough savings for a $1,000 emergency.

There are several reasons for this worrying trend. One of the most evident is debt. The student loan debt crisis is well-known, but there’s also huge consumer debt surrounding credit cards. Mortgage debt is at over $10 trillion, and student loan debt is over $1.5 trillion.

If you don’t think you’re financially prepared for an emergency, you’re far from alone. Like many others, this might leave you asking something like “if I’m serious about saving, what can I do to make sure I’m prepared for emergency expenses?”

Any good financial plan will start with a cold, hard look at the numbers. From there, it’s usually possible to put together a plan that can work. It doesn’t need to be drastic. You want to save enough to be able to save for an emergency. But if you can only set aside $20 per week, after a full year you’ll have an emergency fund of $1040.

Let’s go over how you can maximize your emergency savings.

Audit Your Expenses

2020 poll found that 65% of Americans had “no idea” how much they spent last month. It’s normal to have a casual budget based on your income vs your predictable expenses. But you need to be able to control spending as much as possible to be able to save.

The first thing you should do is order your bank and credit card statements. Look at the records for all of the accounts you have. Then, determine the percentage of your income that goes to each major expense category. A good template to use for expense categories includes the following:

  • Housing (excluding utilities)
    • Mortgage/rent
    • Property tax
    • Repairs
  • Utilities
  • Transportation
  • Food
    • Groceries
    • Eating out
    • Pet food
  • Clothing
  • Medical (Don’t include insurance)
  • Insurance policies (including medical)
  • Household items
    • Toilet paper
    • Toothpaste
    • Detergents
    • All cleaning supplies
    • Etc.
  • Debt repayments
  • Other savings
    • Retirement
    • Kids’ education savings
  • Obligatory gifts
  • Charity
  • Entertainment

Looking to the future, you should systematize your budgeting. You can download one of many free budgeting apps. They will make it so much easier to budget because you can automatically split your expenses into the above categories. Many of them are very intuitive and it can even be fun to use them. By getting in the habit of recording all your spending, you will:

  1. Feel more strongly about your financial decisions as the results will be right in front of your face
  2. Have access to important information, such as the portion of your income going to each spending category

Set Your Savings Goal

Now that you know exactly where all your money is going, including what percentage goes to what category, you’re in a better place to make big plans.

An emergency savings plan should work to cover at least one month’s living expenses. However, if you want to be truly prepared for the worst of circumstances, it’s better to set aside enough for 6 months.

Because we’re discussing emergency savings, other variables should go into your plan. If you have equity in your home, you can take that into consideration. But of course, it’s not good to be over-reliant on equity as an emergency backup, or you may end up putting your home at risk. In the same way, you can consider available credit, but credit cards shouldn’t be the first resort. Credit card interest rates are much higher than rates on home equity loans.

If, however, your mortgage is in an insecure state and you’re already pushing your credit limits, you should set even higher goals for cash savings for emergencies.

Put Together Your Plan

This is the part where you take a hard look at your expenses. You need to think about the possible changes you can make to reach your goal in a reasonable timeframe.

Unless your income is completely stable and consistent, putting a dollar amount as a monthly savings goal isn’t the best idea. It can be impractical in many circumstances. But it’s certainly not the worst way to plan for your emergency savings. For example, if you can squeeze $100 per month from your normal expenses and put them into savings, then do it. But you never know when emergencies come, so it will be better to squeeze more savings into a shorter period. For example, $300 per month for 6 months will provide you with $1,800, which is often enough for an emergency.

Like every form of budgeting, emergency funds often require sacrifices. You may need to cut some of your expenses. It’s normally easier to reduce entertainment costs. If you eat out a lot, you can also switch to homemade meals more often, which can save you money while providing health benefits.

Compartmentalize Emergency Savings

It’s good to separate emergency savings from other savings accounts. But regardless of whether you do so or not, remember to keep your account easily accessible. Many savings accounts offered by banks carry fees on transactions. In some cases, such as online banks, it may be more difficult to access your savings.

If you want effective emergency savings, you need to be able to access the money quickly. Separate checking accounts and having fast access to ATMs will be sufficient. Alternatively, you can make sure you have at least one credit card with enough credit left to cover your emergency. Then, you can pay your credit card back with your emergency savings.

Stick with The Plan As Best You Can

Consistency is key. Following through now, even if it’s hard, can at least partially alleviate your stress when a real emergency comes. So, do whatever you reasonably can to stick with your plan. By setting a realistic plan, you will have an easier time.

Unfortunately, bad things happen every day. But if you can set aside a little time and money to be prepared, you will thank yourself later if something goes wrong.

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