How to Establish an Emergency Fund
It finally happened — your car is smoking and has stopped responding to your commands. With your hands sweating on the steering wheel, you manage to pull off to the side of the road and into a relative state of safety. The first thought in your mind isn’t “what happened to my car” or “why didn’t my mechanic warn me last time I got an oil change?” but instead:
“How am I going to pay for this?”
If you had put away money into an emergency fund, this question would be easy to answer.
Research shows that only 37% of americans can cover an unexpected $500 expense.
Remember the old adage, “a failure to plan is a plan for failure?” well in this case the sentiment certainly rings true. If you count yourself amongst the 63% of Americans who do not have a financial plan for the unexpected, then read on to find out how to establish an emergency fund.
Five steps to establishing an emergency fund
1. Set a reasonable monthly goal
Some experts recommend having three, six or even nine months worth of take home pay stashed away in the event of an emergency such as illness or job loss. But other experts disagree stating that these amounts are simply unrealistic for the average American and instead recommend starting low then building up from there.
Setting a goal of as little as $500 to start can have positive psychological benefits and may help you get on track to saving more over time. Once you’ve proven to yourself you can save $500, challenge yourself to save $1,000 next time.
2. Reduce Spending to Initiate Saving
Take a hard look at your spending. Do you watch enough TV to be subscribed to the complete cable package? Are you really using all of the data included with your mobile phone plan? Regardless of where you choose to spend your money, chances are there are easy ways you can cut down on spending without feeling it.
Maybe it means eating out one-less night a week or buying iced coffee at the grocery store and becoming your own barista every morning. The bottom line is, the more you cut on spending, the more you have available to you to save.
But again, start small. Cut out one area of spending in a month and take a look at your bank account at the end of the month. Do you have some money left? Stash it in the emergency fund for safe keeping.
3. Decide where to put your emergency fund
An emergency fund won’t do you much good if it’s within reach of spending at any moment. That being said, it should also be accessible should an emergency arise. That’s why it’s best to put your emergency money into an account that is “out of sight” but not “out of mind”.
- Savings accounts: While savings accounts are easily accessible, they tend not to earn at decent interest rates.
- Money Market Funds: These accounts offer a lower-risk place to save money and typically offer more attractive rates than savings accounts
- Certificate of Deposits or “CDs”: While CDs may offer better rates than money market and savings accounts, you may be penalized for withdrawing funds before the CD reaches maturation. With this in mind, it may be a better strategy to store a portion of your emergency fund in a CD and have the remaining amount in a more easily accessible place such as a savings account.
- Personal Loans: Taking out a personal loan may make sense if you need to pay one-time up front costs relating to an emergency, or if your emergency fund doesn’t cover the entire expense.
4. Shift your perspective on saving
Self-discipline is a critical component of successful saving. However, for many, developing new habits is a difficult task and often takes a while. One useful strategy in establishing your emergency fund is to treat it like another bill or expense each month.
By tricking yourself and committing to your emergency fund like any other bill you pay, you get used to the idea of not having that additional cash lying around for spending. In addition, you may start to change your spending habits to accommodate this new necessary “expense”.
5. Automate your emergency fund
Once you’ve gotten used to the idea of saving a certain amount each month, set up automated systems to help you continue to save and save more as you see fit. As one financial analyst discovered, automation is the key to successful saving and eliminating as much money related stress as possible has positive psychological effects on your ability to manage money.
You can’t plan your own emergencies (why would you want to?), but you can be ready to pay for them. The bottom line is, when it comes to planning and saving for the future, the most important step is to begin. Once you’ve got that part down, the rest is just commitment and discipline.
* Please consult with your attorney, financial consultant/planner, accountant, and/or tax advisor for advice concerning your particular circumstances. The information contained herein is for general informational and educational purposes only and should not be construed as professional, tax, financial or legal advice or a legal opinion on specific facts or circumstances. The information or opinions contained herein should not be construed by any consumer and/or prospective client as an offer to sell or the solicitation of an offer to buy any particular product or service.