When it comes to your finances, you should always be prepared for the unexpected. That's where an emergency fund comes in handy. An emergency fund is a set amount of cash, ideally held in a liquid and easily accessible savings account, that you can draw on if you have an unexpected expense or a situation that your paycheck doesn't cover.
How much of an emergency fund you need can vary but it's a financial tool that almost everyone needs. Financial emergencies can come in the form of a job loss, significant medical expenses, a vet bill you weren't planning on, home or auto repairs, or something you’ve never dreamed of.
In those situations, you could use a credit card or personal loan to fill the gap but that means taking on debt. Having an emergency fund in place can keep you on solid financial ground. Here's how to build your go-to emergency stash of cash if you haven't started one yet.
Map Out Your Monthly Expenses
Most financial advisers agree that it's ideal to keep between three to six months of living expenses set aside in your emergency fund. Deciding how much of an emergency fund is right for you is the first step you need to consider. Adding up your monthly expenses can give you an idea of how much money you'll need.
Be sure to consider both fixed and variable expenses when determining how much you need to set aside. The following are categories of some fixed and variable expenses you need to consider:
- Housing Expenses: rent or mortgage, utilities
- Insurance: life insurance, renter's insurance, homeowner's insurance
- Taxes: FICA and income taxes
- Debt Repayments: credit card debt, student loans, car loans
- Healthcare: health and dental insurance
- Childcare: if applicable, daycare or babysitter expenses
- Personal Living Expenses: groceries, personal items
- Transportation: gas, taxi, or public transportation
Once you've taken the time to calculate how much you're spending in these categories on a monthly basis, you can then determine how much you need in your emergency fund. If you are married or living with your significant other, be sure to calculate these costs as it relates to both of you so that you can accurately determine how much you need in your fund.
You might also consider adding in extra money if you have children. Some experts recommend adding another $1,000 per child, per month. So if you've determined that your ideal emergency fund is $18,000 ($3,000 in monthly expenses x six months) and you have one child, you'd add in another $6,000 to the total ($1,000 per child x six months).
Start Building Your Emergency Fund
If you don’t have an emergency fund set up yet, start setting some goals for how much you want to save. Aim for $1,000 at first, then work on accumulating one month’s worth of expenses. It will take some time, but if you set your immediate goals to be small and manageable you'll have a better chance of reaching them.
The easiest way to get started saving is by opening a dedicated savings account at your bank or credit union. The next step is to get into the habit of making regular deposits into this account. Automation can make this hassle-free. Whether it's weekly, bi-weekly, or monthly, create a schedule and stick to it. Once you make saving automatic you won’t even have to think about it.
If you're struggling to begin saving start with a small amount. Maybe you begin with $10 a week initially. While this won’t amount add up all that quickly the important thing is to start putting something away and to make it a habit. After a few weeks, you won’t even notice that $10 missing so you can bump it up to $15 or $20 after a month or so. You will begin to get used to that money not being there and can slightly increase it again.
Remember, Your Emergency Savings Is for Emergencies Only
You want your emergency fund to be easily accessible at any time. But, you don't want to feel tempted to dip into that money unless you absolutely need to. So, as you begin growing your emergency savings account, set some boundaries on when and how you'll use that money. For example, if your child breaks their arm and you need to cover the deductible for your insurance, that's an emergency. Coming across a great deal on a pair of designer shoes, on the other hand, isn't.
Keep in mind also that you should be parking your emergency savings in an account that offers a solid interest rate. The higher your annual percentage yield, the more quickly your money can grow. By following these three steps, you'll be well on your way to being prepared for any situation that results in an unexpected financial loss.