Building an emergency fund is an important beginning step towards financial security. If one health bill or car accident will send you into the red, you will be forced to borrow money and pay it back at likely high interest rates. High interest debt, like credit card debt, can be detrimental to your financial well-being. It can feel like clawing your way out of a quicksand hole as the interest payments accumulate on any remaining balance. Saving for your rainy day fund will help prevent this from happening and give you the shock absorber needed for bumps in your financial life.
So how do you build an emergency fund? The common recommendation is to save for six to eight month’s worth of living expenses, though you can always save more. Six months of expenses will come in handy in case of job loss, though you will need to find employment again within six months in order to avoid going into debt. Once an emergency fund is tapped into, it is important to bring it back up once you have income to do so. Life has a way of throwing the unexpected at you--such as a health crisis, car trouble, or home repair--so you will want to make sure your emergency fund is kept full.
For your emergency fund, you will need to calculate your average monthly expenses. You can do so by adding up different budgets: rent/mortgage, utilities, insurance, transportation, food, home supplies, etc. If you have never done a monthly budget, you can visit this blog post for instruction. The average household spends about $4,775 per month, which would stipulate a $28,650 emergency fund. This might seem like a big number, but when you calculate what you will need to save for retirement, it really is just a drop in the bucket. And you will build the emergency fund by saving part of every paycheck, one paycheck (or month) at a time.
Once you have calculated what you need, it is time to start saving. If your initial goal is to save $10,000, you can calculate setting aside $166.67 if you plan to build it in 5 years, or $333.33 per month if you plan to build it in 2.5 years. It is up to you how fast you save. Now, putting this plan into action may require saying no to “fun” things. When you buy a car, consider buying used not new, as new cars depreciate immediately once driven off the lot. Other considerations, like downgrading your cell phone plan, cutting cable, skipping a two week vacation, and reducing your dining out bills can add money to your fund over time in a way that has a real impact. Even skipping a $5 coffee every day will add $1,825 to your pocket in just a year. With budgeting, it can be the small, innocuous seeming expenses that can really add up over time.
Only 39 percent of Americans have enough saved for a $1,000 setback, which is a crazy but true statistic. It is important to view your emergency fund as insurance for setbacks, not as a piggy bank. It keeps you from having to borrow money when unexpected expenses arise. Over time, if you follow these steps, you will find a way to reduce your expenses and start creating wealth.
TABER Asset Management is a fiduciary and financial advisory firm based in Des Moines, IA that serves clients across the U.S. Please call us at 515-557-1860 or email us at firstname.lastname@example.org to learn more about how we can help you to create wealth.