An emergency fund is an essential part of everyone’s
financial plan. This is the money you should have earmarked for unexpected
events, such as a medical bill, emergency room visit or unexpected
hospitalization. Or, it could be your fund to live off in the event of
unexpected unemployment.
The reasons for using an emergency fund are endless, so
it’s critical to prepare and build an emergency fund to avoid letting
unexpected expenses lead you to financial ruin.
“By nature, unplanned expenses are unexpected, so the
sooner you’re prepared the better off you’ll be when the inevitable happens,”
says Greg McBride, CFA, Bankrate’s chief financial analyst.
How to build an emergency fund
Starting an emergency fund can be as easy as splitting a
portion of your direct deposit into a savings account or money market account.
It can also consist of setting up a recurring transfer from your checking
account into a savings or money market account each week, every other week or
monthly.
In addition to splitting a portion of your direct deposit
into an emergency savings account, tally up your expenses at the end of the
month, McBride says, and compare that with your net income.
“If there’s a surplus, you now have a second bite at the
savings apple,” McBride says. “You can move that surplus over into savings.”
Kevin Gallegos, vice president of Phoenix operations for
Freedom Debt Relief, says to set your expectations at a realistic level.
“Any action you can take to establish an emergency fund
will do you good,” Gallegos says. “If you transfer $10 to a savings account
each week, you’ll have $500 in a year.”
If you are not sure where the funds for this emergency fund
will come from, re-evaluate your spending habits and your budget.
Start with a small amount of savings each month, but try to
increase it whenever possible. And anytime you get a tax refund or bonus, add
it to your fund. And gradually boost your savings by selling items you don’t
need, holding a yard sale or putting change into a jar every evening — anything
to slowly accumulate cash.
“By stashing the extra, in addition to your regular
predetermined amount from your budget, you’ll see your savings
soar,” Gallegos says.
How much to save in your emergency fund
Make small goals at first, such as saving $1,000, and then
work your way up to a reserve to cover several months’ worth of expenses. While
your savings goal will depend on your income and expenses, a general rule of
thumb is to save
enough to cover three to six months’ worth of expenses.
Gallegos says that when setting your savings goal, you
should focus on having enough to cover expenses, not on replacing your entire
income.
“Remember, in an emergency, we don’t fund vacations, fancy
new clothes, dining out or other luxuries,” Gallegos says.
Your emergency savings account should be able cover six
months’ worth of expenses, McBride says. For a lot of people, accumulating
that amount of emergency savings is going to take some time.
“That’s a destination, not a starting point,” McBride says.
“… But the important thing is, if you’re saving consistently, you’re putting
yourself on the pathway to get there eventually.”
A sole breadwinner, a business owner or a person with a
highly variable income might want to aim for nine or 12 months’ worth of
expenses in their emergency savings account, McBride says.
Where to keep your emergency fund
Your emergency fund should be easily accessible, but not so
easily accessible that you’ll be tempted to make withdrawals for everyday
spending.
Online banks are good locations for your emergency savings
because you can’t just walk into the bank and withdraw your cash. Consider
keeping emergency funds in a combination of locations, including an online
savings account, money market account and short-term CDs. Online banks
also typically
offer higher yields than brick-and-mortar banks.
Try and determine how quickly you may need these funds in
an emergency and how you would be able to transfer, withdraw or use these
funds.
Since you might be forced to use an emergency savings
account as a transactional account in an emergency, a money market account may
be a great option – assuming the APY is competitive with the top savings
accounts available. But there is nothing wrong with having your emergency funds
in a savings account either, since there should be a way to get those funds
into a transaction account if needed.
Click
here for the original article from Bank Rate.