What would you do if you suddenly were faced with a major expense like a $1,000+ car repair or the roof started to leak? Or what about if another pandemic were to strike and put you out of work indefinitely?
According to a nationwide poll by Bankrate, fewer than 4 in 10 Americans have enough money set aside to cover an unexpected $1,000 expense. They go about living paycheck to paycheck never realizing that they might just be one incident away from financial ruin.
There are countless stories of people who’ve been in accidents, and even though they had great insurance, they still had medical bills that were tens of thousands of dollars. Without the financial means to cover it, their only choice is to turn to high-interest credit cards and personal loans. And once that door opens, it’s a slippery slope into a spiral of debt.
The good news is that you don’t have to settle for a fate like this. You can protect yourself by creating a safety net and putting a barrier between you and debt. To get you started, here are seven tips on how to build up an emergency fund.
1. Track Your Expenses
The design of an emergency fund is that you should be able to continue your lifestyle without disruption even if your income was suddenly cut off (from something such as a job loss). Therefore, in order for you to build one up, it’s imperative that you first measure and find out just how much your total monthly expenses really are.
An easy way to track your budget is to use an app like Buxfer. Buxfer connects to your bank accounts, credit cards, and about 20,000 other financial institutions. Every transaction you make will be collected and compiled into a real-time report that you can access any time you need it. That way, you’ll always know exactly how much you’re spending and what your true monthly spending levels are.
2. Determine Your Savings Target
Since the goal of an emergency fund is to cover your living expenses for the next 3 to 6 months, your target savings goal should be at least 3 to 6 times your monthly budget. Take the number you found in Step 1 and use this as the basis of your calculation.
For instance, if your living expenses are $5,000 per month, then you should strive to save up between $15,000 and $30,000 in your emergency fund. If you’re self-employed or your income is inconsistent (such as working on commission), then you may want to err on the higher side for added security.
3. Create a Separate Bank Account
A lot of people make the mistake of putting their emergency savings into their regular checking accounts. But the problem with this is that every time you log in, you’ll see that money and be tempted. You might want to spend it, invest it, or just plain stop contributing to it because you feel like you’ve got other financial priorities.
This is why many financial experts recommend creating a separate bank account devoted to only your emergency savings. This step may sound silly at first, but there’s a psychological advantage to it.
By having your emergency fund in a separate account, you’ll be far less tempted to ever touch it. Why? Because when something is out of sight, it’s also out of mind. While that might be simplistic, it’s a strategy that works.
4. Setup Automatic Contributions
Don’t wait until you receive a windfall or have a little extra in your checking account to contribute to your emergency savings. Just like how your 401k plan is set up to receive money every time you get paid, the best way to start funding it is to treat it like any other bill and pay yourself every time you get paid.
This can easily be done by setting up an automatic bank transfer from your regular bank to the one hosting your emergency fund. You can pick any amount – $100, $200, etc. – whatever you can afford to start setting aside. Obviously the more you contribute, the faster you’ll reach your goal.
5. Gradually Increase Your Contributions
Whenever you come into more money or your budget frees up, use this as an opportunity to put even more into your emergency fund. For example
- If you pay off a debt, continue to allocate those same payments into your savings instead.
- If you get a raise at work, divert that extra income (or at least a portion) into your emergency fund.
- If you take a side hustle and earn an extra $100 or $1,000 per month, be sure to save some of it.
Again, make saving a priority and treat it just as seriously as any other bill you’d have to pay.
6. Go for the Top End of the Range
If you hit the 3-month savings target, congratulations! But don’t stop there … you could keep going for a 6-month or even a 12-month multiple.
Really … 12 months? Yes! Financial gurus such as Ramit Sethi, the New York Times best-selling author of “I Will Teach You to Be Rich”, recommend having a year’s worth of expenses, especially given how much the COVID-19 pandemic has ravaged household budgets.
Although you’ll often hear people in the media criticize emergency funds, don’t be worried about having so much cash on hand. While it might seem like all this money is sitting around accomplishing nothing, it’s actually working as an insurance policy to keep you out of debt. And that type of security is priceless.
7. Stay Disciplined
As your emergency savings builds up, it will be very tempting to do other things with it. You might want to buy a new house or buy a vehicle. Or you may even wish to do something with an ROI (return on investment) such as buy stocks, pay off debt, or start your own business.
But please don’t! Please leave it alone and don’t succumb to temptation. This money is there for when something unexpected happens. And trust me – you’ll be happy to have it when you’ll truly need it.
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