Emergencies happen. The entire world learned that the hard way with the coronavirus crisis.
Millions of people also learned they were not financially prepared. About 40% of Americans don’t have $400 in savings, according to the Federal Reserve.
The pandemic showed how vital it is to have an emergency fund. But how do you start one? How much do you need? Where should you put that money?
Here’s a guide to building a fund that will stand up to your next emergency.
An emergency fund is an amount of money you set aside for an unforeseen (and expensive) dilemma. The most obvious plight these days is getting laid off from work, with the unemployment rate skyrocketing toward 20% in June 2020.
But life had plenty of financial potholes before anyone ever heard of COVID-19. Cars broke down, appliances needed replacing, medical problems popped up. That stuff will be happening long after COVID-19 fades away.
If you’ve been laid off and don’t have $493 in the bank, the answer to your financial problems is obvious. You need an emergency fund to survive.
You’ve still got rent to pay; food to buy; and utilities to take care of. Your car breaking down isn’t as dire, but it’ll still need fixing. Many people aren’t able to simply write a $2,000 check for a transmission repair job or similar problems. An emergency fund gives them quick access to needed cash.
Why is that important? Consider the alternatives:
If you have nothing right now, aim for $1,000. Then start building until you have put aside 3-6 months worth of expenses.
By that, we mean create a budget by adding up your fixed costs like mortgage, car payment, utility bills, food. You know, the essential expenses of life. A budget will help you determine how much money you need to cover bills on a monthly basis.
The average household spends 62% of its income on such things, according to the Bureau of Labor Statistics. Don’t include non-essentials like dinner at Morton’s steakhouse or tickets to “Hamilton.”
When money is tight, it’s no time to splurge.
If you have a calculator, figuring out how much you need is easy. Figuring out how to save that amount is where the work really begins. Here are few steps to get you started:
Remember, it should be a fund unto itself. Funneling emergency money into your checking account or other savings accounts makes it too easy to use in non-emergencies.
Sticking it under your mattress is also not a good idea, since your mattress does not pay interest. Investing your emergency fund in stocks, bonds or mutual funds is also not advisable. They are designed for long-term growth and their values fluctuate.
Your best options are:
These are bank accounts that earn you a higher interest rate than traditional savings accounts. They are easy to access and federally insured up to $250,000, so your money is safe.
Unlike putting your money in stocks or bonds, there’s not much risk in a savings account. There’s also not much reward.
It’s not uncommon for banks to pay 0.01% interest on savings accounts. With inflation, you might actually be losing money.
High-yield interest rates typically pay 1% to 2.2%. If your bank does not offer one, there are plenty of online banks that do.
About 78% of Americans are living paycheck to paycheck, according to a CareerBuilder survey. A lot of them have undoubtedly tried to save money, but those best-laid plans got lost in life’s merry-go-round.
Getting organized is the first step to getting out of debt and saving money. The good news is there’s help out there.
Nonprofit organizations like InCharge Debt Solutions offer free credit counseling to discuss your financial situation. There are strategies, like a debt management program, that find lower interest rates and consolidate your bills into one monthly payment.
That will help get you in the position to start saving for an emergency. You never know when one will hit. But sooner or later, you know one will.