How to Build an Emergency Fund
How to Build an
Emergency Fund
Everybody knows that they need a little bit of money saved up for a rainy day because you never know what could happen. It is always better to be safe than sorry to avoid a disaster. But the numbers and the amount you need to save can be daunting. On average, experts say you need about 3-6 months of living expenses saved up. On average, 27% of American families have begun having conversations on building up their emergency funds since the start of this recession and approximately half have actually started putting money towards their emergency fund.
So
what is the point of an emergency fund? Well an emergency fund is a safety net
for all kinds of situations; it could be as simple as an unexpected car repair
to losing your job. An emergency fund is meant to be saved until an emergency
comes and than to be used immediately so that you do not need to take on any unnecessary debt
to keep yourself afloat.
So how do you save money when you are already just barely making ends meet? You need to take the time to following some very simple steps. The first step to building your new emergency fund is to reduce any debts that you currently have. For those of you that may need help reducing your debt, here are some quick tips:
- Try to pay at least the minimum amount on each debt as this will help protect your credit rating and it can help you organize which debts can be paid down first. Usually the rule of thumb is to pay down the highest interest rate debt first so that you can reduce how much you pay in interest monthly.
- You can also reach out to your lender and ask for a lower interest rate. Usually when it comes to credit cards, you can ask for a lower interest rate and they will help you transfer your credit card to another credit card that provides you a lower interest rate for 6 months. This will give you enough time to pay it down quickly without accumulating more debt.
- If you think that your issue with debt is that you use your credit cards too much, you can also try to only pay your expenses with cash or your debit card. Do not cancel your credit cards as it is important to keep them open to help improve your credit rating but you can avoid debt by putting them somewhere safe and out of sight so that you don’t feel the need to use them and spend money that you might not have.
- Talking to a professional could be beneficial as they can help you develop a plan to reduce your interest payments and help you get out of debt faster. These professionals can also be found at non-profit credit agencies so other than a longer than normal wait time, they are free to use.
After
we have dealt with any potential debt issues, we can begin building up our
emergency fund. It is important to realize that a part of this goal has nothing
to do with the money itself. Its actually about building up the discipline to
learn how to save money and not to spend it when you find yourself wanting something.
The next step would be to automate your savings. This can be easily done with
all banks by setting up an auto-save where every time you receive your
paycheck, the bank takes 5% of that money and puts it directly into a separate account
that acts as your emergency fund. Usually, when you are just starting off, you
can choose a lower goal, like $250 a month, and put it away. The main goal we
are trying to achieve is to change our mindset and create this idea that saving
consistently is good and will make us feel safer if anything bad happens.
Always remember that no matter how much money you save, it is always better
than not saving at all.
So
how much do I need to save? Now most people will recommend a specific fixed
amount, such as $5,000, or a few months of living expenses but these rule of
thumbs do not work for everyone. I personally believe that you should look at
your own personal situation and try to save up 3-6 months of your lifestyle
just in case something terrible happens like you lose your job. This is because
there are some costs that you simply cannot stop paying from one month to another;
you will still need a place to live so you still have to pay rent. If you have
children, the cost of sending them to school with healthy lunches is not going
away either. So for example, if your average monthly cost for your lifestyle is
$1,500, you should try to save up between $4,500 or 3 months of living expenses
and $9,000 or 6 months of living expenses. Now I know that this sounds like a
ton of money but as we said before, this is not something that happens
overnight, it takes months, sometimes years, to be able to build up a strong emergency
fund and that’s alright. The hope is that you never need to use this money and
its simply used for peace of mind. But, if ever you end up needing to use this
money, it’s there and you don’t have to worry about money during a financially
difficult time in your life.
Now,
if your emergency fund is not as high as you were hoping, you might be able to
help it out by picking up a side hustle. Here are a couple of ideas that I find
really help you make some extra cash on the side. Also, to help out, don’t forget
that you can always cut a couple of those luxuries that we all have. Maybe, to
help save up a bit of money, you cut your gym membership for a couple of months
and start working out at home.
Also,
if you are younger, you might not even need 3-6 months of living expenses. If
you are able to stay with a friend or move back in with your parents for a
while if you lose your job, than your emergency fund might not need to be 3-6
months but maybe more like 1-3 months. That’s why its important to take a look
at your own financial situation and adapt everything being said here to your
personal situation.
For those of you who find that saving $4,500 or 3 months of living expenses is a huge number, sometimes all it takes is to look at this number differently. It might be easier to look at your savings as a percentage of your income rather than a lump-sum of money. So instead of looking at needing to save $4,500 in your emergency fund, you can just say that you need to save 10% of your income. Assuming your income is $45,000 a year, 10% would be $4,500. So instead of trying to save some money here and there, you can just tell yourself that after a year you will have saved your entire emergency fund as long as you save 10% of your income every paycheck. I find that this is easier for people to understand and it helps motivate them to save more.
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