Everyone should have an emergency fund, but you probably won’t know how much your fund should be unless you know what your basic monthly expenses are. Financial advisors usually suggest having enough savings in an easily accessible account to cover your living expenses for three to six months, but it’s not a one-size-fits-all situation. Depending on the number of breadwinners in your household and your other sources of cash, your family may need more than six months of expenses in an emergency savings account. Having this financial safety net will give you peace of mind about how you’ll meet your most basic financial obligations in the event of illness, job loss, unplanned expenses such as major house or car repairs, or medical costs not covered by insurance. If you’re uncertain about your job and the job market, an emergency fund is especially important.
When you have a budget in place, you can easily calculate how much money you’d need to cover your basic, no-frills living expenses if you had a sudden loss of income. Write down your goal for your emergency fund and decide on an amount to contribute to it each month, using the “pay yourself first” rule. Keep the fund in a separate account, such as a money market account (not a money market fund, which is not FDIC-insured), so you’re less tempted to dip into it for nonemergencies. Since emergency funds might be needed without notice, they should be kept in liquid accounts that are easy to cash in quickly.
Don’t be discouraged if you feel like you have no extra money to put away. By developing a realistic budget and setting spending and saving goals—and sticking to them—you can create money for savings, even if it’s a very small amount to start with.
Decide on a percentage of your income to designate as savings. Financial planners suggest 10 percent, but if 5 or 2 percent is all you can handle at the time, start with that. Don’t make the mistake of thinking that if you can’t save a large amount of money all at once, it’s not worthwhile to try. This couldn’t be further from the truth. If you saved $25 a month at 2 percent interest, in five years you’d have $1,578. If you saved $100 a month at 2 percent interest, in five years you’d have $6,312; in ten years you’d have $13,282.
Set up a separate savings account. If you mingle your day-to-day funds with your savings, it’s almost inevitable that you’ll end up using some or all of the savings, and you may never repay them. There’s also a mental component. Seeing your savings balance grow from month to month and your financial goals becoming more of a reality is highly motivating.
If you have direct deposit at work and your employer allows you to split your deposit between multiple accounts, consider having a set amount deducted from your paycheck each pay period and deposited in your savings account. It’s much easier to save when the money doesn’t have to take a detour to your checking account before reaching your savings account. If you don’t have this option at work, set up an automatic transfer into your savings account. Online bank accounts will do this for free—they’ll even pull money from a different bank. After a while, as you adjust your budget and spending, you won’t even miss the money you’re putting into savings.
Think of It As a Loan
If you feel forced to dip into your savings in an emergency, consider it a loan. If you can’t pay it all back at once, set up a repayment plan and pay yourself as though it were a regular bill. Otherwise you may never replenish your emergency savings.
Use windfalls to pump up your savings instead of spending them. Bonuses, tax refunds, rebates, overtime pay, income from hobbies or yard sales, cash gifts from family, lottery winnings, and other sporadic cash receipts can make faster advances toward your goals without requiring additional spending cutbacks. When you receive a salary increase, put all or part of it into savings each pay period and continue living on your previous salary. When you pay off a loan, continue putting the payment amount aside each month, but pay it into your savings account instead of to the bank or finance company. Because you’re already in the habit of doing without that money, you won’t even miss it.
With a spending plan, you don’t need to deprive yourself of things you really want, but you should question whether you really do want them. Experts recommend these strategies:
Product Reviews
You can find product reviews and cost comparisons online—just be sure the source is reliable and impartial. One good site is www.consumerworld.org, with product reviews, price comparisons, airfare and travel deals, and lots of other consumer resources.
If you’re like most people, you tend to go overboard on holiday spending, but you can avoid overspending on gifts by setting spending limits. Using your budget, figure out how much you can realistically afford to spend on gifts without going into debt. Make a list of all the people you’d like to buy gifts for, including small gifts for babysitters, teachers, newspaper carriers, and so on. Set a limit for each person on your list, then add up all the amounts and make sure they don’t exceed your overall spending limit. Try to allow a cushion for unexpected items or price fluctuations.