I share a recent article written in Investopedia:
Version:1.0 StartHTML:000000316 EndHTML:000046143 StartFragment:000017952 EndFragment:000046076 StartSelection:000018026 EndSelection:000046066 SourceURL:https://www.investopedia.com/personal-finance/how-to-build-emergency-fund/?utm_source=personalized&utm_campaign=aca_bx&utm_term=16189768&utm_medium=email How to Build an Emergency Fund
To quote the American poet Henry Wadsworth Longfellow, “Into each life some rain must fall/Some days must be dark and dreary.” To deal with those dark days, having an emergency fund is a necessity. Think of it as a shock absorber for the bumps of life, one that’ll keep you from adding to the load of debt you doubtless already carry. Here we look at how much you’ll need to save for your emergency fund and how you can get started.
While some call having one to two months’ wages in reserve ideal, most fnancial experts recommend that people maintain an emergency cash reserve large enough to cover three to six months’ worth of household expenses. That’s a great idea, but it also requires some effort to achieve. The first step in the process is to figure out how much you spend each month. Consumer expenditure statistics from the U.S. Department of Labor indicate that the average annual expenditure per consumer unit, which is similar to a household, is $57,311, as of 2016 (the most recent year for which data is available). This data is broken down by month in the table below. The months in bold highlight the cumulative quarterly expenses, and therefore, the recommended cash reserve for the average household.
|Number of Months||Cumulative Expenses|
Source: Based on average annual expenditure figure from the Bureau of Labor’s Statistics’ Consumer Expenditures–2016 release
While your household expenses may be higher or lower than the average, there’s no doubt that even three months’ worth of expenses is a big number. One look at that number and the average person’s first reaction is, “I can’t come up with that kind of money.”
Why So Much?
The amount of money required to fund a proper emergency fund is certainly significant, but we live in uncertain times with uncertain economies. Corporate loyalty is a thing of the past and unemployment can happen unexpectedly, usually at the worst possible moment. Likewise, emergencies like sudden illness or disability, major car repairs or a new roof, can be expensive and there’s never a good time for these things to happen.
While it’s probably true that you don’t have an extra $14,327.75 lying around, everything is relative. Even six months’ worth of expenses is a puny number compared to the amount you will need to save for retirement; there’s not a savvy investor out there who balks at the idea of stashing away so much money that he or she will never need to work again. When compared to what you’ll need over the course of 20 or 30 years in retirement, three months’ worth of expenses doesn’t look like much. (For more on retirement savings see How To Maximize Your Retirement Income.)
Crunching the Numbers
Now that you have things in perspective, it’s time to start saving. Approach this effort the same way you would approach any other financial goal. Put together a plan and execute it. The first step is to determine how much you spend each month. Housing, transportation and food will likely be the categories that eat up most of your cash. The average household spends nearly 60% of its income (which averages $74,664 before taxes, according to the BLS Consumer Expenditures report), on these items.
Once you know your total expenses for each month, multiply that number by three. Reaching that number will be your initial goal. To achieve your three-month target, you need to start saving money.
If we assume your initial goal is $10,000, the table below illustrates how much you will need to save each month, over a five-year or a 2.5-year period.
|5-Year Plan||Amount Needed per Month||2.5-Year Plan||Amount Needed per Month|
|60 months||$166.67||30 months||$333.33|
Putting Your Plan into Action
Buying a less expensive car, the next time you are shopping for an auto, and downgrading your cell phone service are two easy ways to come up with some cash to fund your savings plan. Skipping that two-week vacation, cutting down on the amount you spend dining out, and saving your next raise or bonus are also simple methods of adding to your emergency fund.
The key is to add to the emergency fund at regular intervals. Ideally, you should treat your it like any other recurring bill that you must pay each month. Dedicate the appropriate amount from your paycheck and set it aside. While most people have no qualms about regularly sending enormous amounts of money to credit card companies, they balk at the idea of paying themselves first. Change that equation.
If you are among the many investors who don’t have a rainy day fund stashed away in case of emergencies, there’s no time like the present to start saving. Even if you don’t have the dedication to address the project with a dedicated savings program, you can start simple: Take the change out of your pockets at the end of the day and put it in a jar. You could also eat at home instead of dining out and “tip” yourself by adding a few bucks to your emergency fund. If you get cash back on your credit cards, or just paid off a big debt, such as a personal loan or an automobile, put that newfound money into your fund. If you get a tax refund, deposit the check into your fund. If you manage to dedicate just $5 per day to your effort (less than the cost of lunch!), you’ll have $1,825 at the end of the year; that’s $9,125 in just five years. (For more money-saving ideas, read Top 5 Easy Saving Tips.)
Money market funds or high-interest savings accounts are good places to park your emergency fund: They’ll make it harder for you to dip into it (face it: you’ll be tempted to from time to time) and you’ll earn a bit of return on the money, too.
The Bottom Line
View your emergency fund like an insurance policy. Once you have it, guard it carefully. It’s not a piggy bank; you should not using it for incidental expenses. In fact, as your salary rises, be sure to up the amount to match your new situation.
Use the fund only in the event of an emergency and hope that emergency never happens. Remember, once that money is spent it always much longer than anticipated to replace it. Start now and save whatever you can, even if it isn’t much. Some day, when you need the money, you’ll be glad you did. You’ll be able to weather those rainy days, without running up a credit card balance or taking out a personal loan.
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A great article sharing key thoughts:
The cost of free advice
……anyone can give their opinion, but not everyone is qualified to give financial advice……
When should you see a financial adviser, and when not?
“Honesty is the best policy” (Benjamin Franklin)