Did you know the average cost of an unexpected financial emergency in the US is $3,500? But about half of people don’t have enough to cover a $1,000 emergency. So how do they pay for it?
Most turn to credit cards, personal loans or borrow money from family
But imagine if you had the money to cover a financial emergency without having to go into debt or having to ask a family member. An emergency fund is key to surviving a financial crisis, like unexpected medical expenses, home repairs or car issues.
Here are tips on how to build an emergency fund – and when you can use it.
Why Do You Need an Emergency Fund?
An emergency fund can keep you afloat in times of unemployment and help you pay for a large, unexpected expense without going into debt.
If you're already in debt, you'll definitely want an emergency fund to keep debt from growing larger. Emergency funds can be used for car repairs, unexpected medical expenses, appliance repair or even unemployment. The COVID-19 crisis is a prime example of why an emergency fund can be useful for your cash flow.
How Much Should You Save?
The big question is how much you should have in your emergency fund. Most experts agree you should have between three and six months' worth of expenses saved. To determine how much you need, figure out how much you spend each month on housing, utilities, food and other necessities.
Once you have this number, multiply by three (or four, five, or six) to figure out what amount you're aiming for. The number might seem intimidating, but don't let it overwhelm you. Start small and work your way up to a fully funded emergency fund.
Pay Down Debt While Saving
Paying down debt and saving money doesn't have to be an either/or scenario. Rather, you can do both. Here is where the saying "pay yourself first" comes into play.
Don't wait to see what's left at the end of the month to put money in savings. Instead, pay yourself first and put that money into an account where it will earn interest. You can even request that your employer direct a portion of your check into a savings account. That way, it’s taken out before you get a chance to spend it. Or when you have extra cash, you can send it to your savings account. But make sure you look at your upcoming cash flow before you make a transfer so you don’t overdraft your account. You can use Thinkflow’s forecasting tool to see when you might have extra cash to save.
Make your savings account a priority and pay yourself first before you pay anything else. Even if you can only transfer $50 a month, it adds up fast.
Once you pay yourself, prioritize other bills. You can use the snowball method, where you start with the smallest debt first, or the avalanche method, where you start with the debt that has the highest interest rate, as a way to pay down your accounts.
High-Yield Savings Accounts
You might be tempted to funnel money into a regular savings account linked to your checking account. However, the average interest rate on savings accounts is only 0.07%. This means that if you have $1,000 in your account, you'll only earn $7 from interest in a year.
But if you open a high-yield savings account, you'll earn more in interest. There are several online-only savings accounts that have higher interest rates. Because they don’t have brick and mortar locations, they can afford to give you a higher interest rate. Another benefit of these accounts is that you tend to forget about the money – out of sight, out of mind.
Set up an automatic deposit every time you get paid. The fact that you can't easily dip into it (because it takes a few days to transfer the funds to your regular savings account) will make it less likely that you'll spend it on something that's not an emergency.
To build your emergency fund fast, you'll likely need to change your spending habits. This is where a budget is useful.
Track your expenses for a month or go over your old bank statements and see where your money is really going. Once you know how much you’re spending each month, you can make adjustments where you can.
Fixed expenses, like your rent or mortgage, car payment, and utilities might stay the same, but there are many areas you can reduce. For example, eat at home more often or cut the cord on cable.
This way, you can prioritize saving and cut your spending.
Setting and Meeting Financial Goals
A good way to meet larger financial goals is to break them up into small steps. You can set monthly, quarterly and yearly goals as you work your way up to fully funding your emergency fund. Once you meet your goals, reward yourself!
Figure out what keeps you going and treat yourself when you meet your small goals. It doesn’t have to be expensive and can be a great motivator to keep going down your new financial path.
To build an emergency fund, start small, don't overwhelm yourself and set achievable goals to keep yourself motivated.
We can help you with your cash flow projections and additional income streams with our tools right here on Thinkflow.