What if you lost your job tomorrow? Would you have money to live on until you found another job? What if something happened to your car and you were facing a $1,000 repair bill? What if you get sick and end up in the hospital for a few days, would your insurance cover the whole cost? These are just some of the possible uses for an emergency fund.
An emergency fund is your safety net when the unexpected happens. The idea is to sacrifice the surplus today so that when the chips are down tomorrow you’ll have something to fall back on.
Starting an emergency fund is one of the most basic ways to begin building your financial future. It’s also one of the most important steps in personal finance. If you’re spending exactly what you make or worse –more than you make, you’re treading water just to get by. You’re one emergency away from disaster. By building a healthy emergency fund, you can protect yourself from life’s surprises that will eventually come.
So how do you set up an emergency fund? Start by choosing a bank and setting up a savings account with them. A savings account is the best place for your emergency fund because it’s separate from your checking account, but still easily accessible if you need it. I have my account with an online bank. You could also opt for a traditional bank, but either way I recommend linking it to your checking account, which makes transfers a breeze.
Easy accessibility is the key here. You don’t want to put your emergency fund in a CD or in stocks because those are longer-term investments. Even though the interest you will earn in a savings account at today’s rates is lower than 1%, it’s still the best place for your rainy day savings.
How large should your emergency fund be? That depends on your family size, job stability, and other factors. A good place to start regardless of your situation is $1,000. You can get there in a year if you put away just $84 a month. Set up a monthly automatic transfer into your savings account to simplify the process.
When you get to a grand, focus on paying down high-interest debt. When that’s gone you can start building your emergency fund to one month’s living expenses for your family. When calculating what that amount would be for you, don’t include luxuries like entertainment and travel expenses. These can be eliminated during hard times if needed. When you get to one month’s worth, go to 2. Then 3. If you can manage it, build your emergency fund to six month’s living expenses for your family.
Once your emergency fund is in place, don’t touch it unless it’s truly an emergency. It can be tempting to spend money that’s just sitting there. That’s why it’s best to put it in a savings account and forget about it.
Saving for a rainy day is one of the best things you can do for your future. It acts as a buffer between good times and bad. Don’t wait until disaster strikes to start saving.