Stuff happens. And when it does, it usually costs money. Your car’s transmission goes out. Your spouse needs emergency dental surgery. You lose your job. If you don’t have cash on hand to pay for these kinds of unexpected events, it adds financial hardship to the already high emotional and physical stress levels.
This is why most financial experts recommend that you have an emergency savings, or “rainy day,” fund. Unfortunately, half of U.S. adults do not have a stash of cash to buffer them against life’s unpleasant surprises.1 If you’re in this group, it can be beneficial to start working on your rainy-day fund today.
How big should your emergency fund be?
Some experts say you should save the equivalent of three to six months of your take-home pay. If you’re a single renter with a good job and cool parents who would let you move back home in a pinch, then three months may be adequate. If you’re married with kids and paying a home mortgage, six months’ worth or more might be a better target.
A more conservative benchmark is to have enough cash to cover three to six months of your basic living expenses. Obviously, this amount would be less than your income. If you get hit with a job loss, you’ll need to keep paying for housing, utilities, food, insurance, health care, transportation and other life essentials. Use only these critical expenses to figure your monthly emergency needs. You can temporarily do without entertainment, eating out, shopping and other discretionary spending, so leave these costs out of your calculation.
Don’t get discouraged if you can’t reach the three-to-six-month goal right away. Any amount is better than nothing. Even $1,000 in reserve could help you get through a few small bumps that otherwise might require you to use the high-interest credit cards and go into debt.
How can you build it up?
Like any savings plan, you should identify your end goal, start small and save consistently. Here are a few tips:
- Set a monthly target. Take a percentage of each paycheck and have it automatically deposited into your emergency account.
- Allocate extra cash. Resolve to put all or part of any extra income, such as a tax refund, a bonus or gifts from grandma into your fund.
- Trim expenses. Cut back on entertainment spending and funnel the savings into your fund. Tell yourself the scaled-down lifestyle is only temporary until you can build up your emergency savings.
- Earn extra income. Get a part-time job, find contract work or look for other ways to supplement your income on a short-term basis.
Where should you put your emergency savings?
The whole point of an emergency fund is for it to be available at a moment’s notice, since emergencies rarely give you any warning. Generally, that means keeping your money in a savings account at a bank.
The downside of this tactic is you’ll earn very little interest on your money in today’s extremely low interest-rate environment. In fact, it’s likely that rising expenses and inflation may cause your emergency fund to actually lose money over time. You may need to keep topping it off to maintain your target balance.
For this reason, make sure you don’t save too much in your emergency fund. Think of it like an insurance policy. You may never use it all so there’s no reason to over-fund it when you can put extra money to better use in a retirement fund or other higher-earning investments.
Financial protection against the unexpected.
If life throws you a curve, you don’t want to max out your credit cards, drain your retirement plan or sell investments to cover expenses. Having an emergency fund can give you flexibility and relieve some stress when the unexpected happens. The key is a willingness to sacrifice a little today for more security tomorrow.
1 (2017). 2016 FINRA National Financial Capability Study. Financial Industry Regulatory Authority. Retrieved May 4, 2017, from http://www.usfinancialcapability.org/results.php?region=US