Regardless of your stage in life, one of the fundamental building blocks of a solid financial plan is emergency savings.
According to a 2014 Bankrate survey of 1,000 U.S. adults, 60 percent of Americans could not afford to pay for most unexpected expenses. Without an emergency fund, you may be just one unforeseen accident or event away from a serious financial setback.
The following are the five W’s for building emergency savings.
WHO needs an emergency fund?
You! Me! Everyone! Whether you are starting your first job, have been retired for years, or somewhere in between, everyone needs to have emergency savings in place.
WHY do I need an emergency fund?
It doesn’t matter how much money we make or how well we plan, bad things happen from time to time. Whether it’s the car breaking down, unexpected medical expenses, or a job loss, something will inevitably occur. An emergency fund will help ensure a short-term setback doesn’t turn into a long-term financial disaster.
WHAT is a good emergency fund target?
There are different opinions on how much money needs to be set aside in an emergency fund. Recommendations generally range from three to six months of your necessary monthly expenses. The bottom line is you need to set a target that feels reasonable to you by looking at your expenses. How much would you need to cover the basics of food, clothing, and shelter if you suddenly found yourself unemployed or unable to work? This amount can seem daunting at first, but the idea is to put a small amount away each week or two and build up to that goal. You may also want to consider adjusting the amount based on your bill obligations, family needs, job stability, or other factors.
WHERE should I keep my emergency fund?
The purpose of an emergency fund is to have funds available during an emergency. Therefore, this money should be in an account where it can be retrieved without penalty or loss to the value. Just make sure it isn’t so accessible that you could be tempted to dip into these funds to pay for non-emergencies (like vacations or new shoes).
WHEN do you need to start an emergency fund?
How did you know I was going to say NOW? Even if you have debt, emergency savings should still be a top priority. If you have a financial emergency and no cash, you may have no choice but to turn to high interest credit cards and loans, foreclosing on your home, or even bankruptcy. As a result, having emergency savings of at least three months of your salary should remain a top priority. That isn’t to say you should pick one over the other; you can work towards emergency savings and debt reduction at the same time.
Bonus: HOW do I save for an emergency fund?
I know ‘How’ is not a W word, but it does refer to another important part of a good financial plan – a budget. Most people don’t have warm and fuzzy feelings about budgets, but the best way to be efficient with your money and to grow your emergency fund is to be aware of your spending and assign every dollar a purpose. Taking the time to do so will ensure your money is working hard for you.
The first step is figuring out where your money is going. If you don’t have an emergency fund or think you don’t have the money to save, take an honest look at where your money goes each month. Ask yourself: If I lost my job, could I still afford this? If the answer is no, it’s a want, not a need. Cut back on those wants and put those dollars toward the emergency fund that you need.
Saving money isn’t always easy, but it’s likely to be less painful than the alternatives. An emergency fund, regardless of the size, is an essential part of a well-rounded financial plan. Having a “safety net” of emergency savings will allow you to feel more secure and prepared when the unexpected happens.
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What constitutes an emergency? Intuitively, we know what would be considered an emergency, but it needs to be defined to avoid misconceptions. A shopping spree after a tough day or an impulse trip to Vegas does not typically qualify as an emergency. Emergencies are those bumps in the road that can derail our long-term financial goals. Things like:
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This article was first published in the Summer 2015 edition of the Retiring Right newsletter. Click here to view other newsletters. Not receiving your newsletter, update your address by completing the Change of Address form.