This past week has been hectic – from dealing with appointments after coming back from vacation (and doing loads of laundry… pun intended) to getting rear-ended and dealing with insurance adjusters. Not fun for anyone- ever, but there are always times when you will find that you will need some extra money to get you through. (I now have utter respect for my mom. She had to do multiple full time jobs!)
How do you get those extra funds? You start building and growing your emergency fund. Building this fund can be tough for some people because you continually want to spend the money that you earn – and you should but have a plan to set some aside for a rainy day. I would even recommend having two accounts: one for an emergency fund (bigger emergencies like job loss) and one for a rainy day fund (like your car needing a new battery).
Regardless, you want to take a look at this guide as to how to build your emergency fund.
Step 1: Planning
I am a planner at heart, but just like in everyday to day life, it helps to plan when it comes to your finances. While we all don’t like to think about it, you want to plan for the worst. Anything from losing your job to getting in an accident, you want to make sure you are covered. Most people think that if they have insurance that they will be fine – and yes, that definitely helps.
Write down anything that you want your emergency account to cover. Job loss? Car accident? Insurance deductibles. People tend to have a high insurance deductible because it means that their monthly payments will be lower which is fine, except when it comes to the instance when you need to use your insurance. BAM – $500-$1500 and the insurance company wants you to pay now!
Once you decide what you want the account to cover, add some cushion to it. If you plan for unemployment for roughly 3 months, add another 3 just to be safe. What would be worse than running out of money!
Step 2: Set up an Account for You & Your Bills
Pick a NEW account that you can use or one that you recently created to house your emergency savings stash. It is important to have your money separate from where you pay your bills (like your debit account) because you might be temped to spend some of your extra cash. Additionally, it is helpful to have it somewhere where you might not be looking at the account value everyday.
I would recommend investigating some of the online banks like Ally or Capital One. It is easy to set up automatic transfers to them and they typically have a higher rate of return. Why do you care about the rate of return? Well, since you (hopefully) will not be using this cash that frequently, your cash will be sitting there and you want it to grow a little bit if possible. Some robo advisors, like Betterment, even have a profile for an emergency fund where your money is invested and can compound while you are working towards your savings goal.
Step 3: Set a Goal Amount
How to best set a goal amount is to work backwards. Take your list from step one and put an expense to them. For example, if you want to cover for job loss, take what your monthly paycheck is (lets say $4,000 for the month) and multiply it by 3 (3 months you want to cover for your unemployment). $12,000 you should have in the account if you lose your job.
WOAH – I know $12,000 seems like a lot and there is still more on your list. It is okay – maybe you don’t use all $4,000 on all of your spending (and you shouldn’t be either). Subtract what you don’t spend regularly on. For example, if you know rent is $1300/mo, car payment is $250/mo, insurance is $75/mo, student loans is $100/mo, gas and bills is another $200/mo, and eating out is roughly $200 a month, your total would be: $2,125. Take that number and multiply by 3 and you get $6,375. Not as scary.
What you want to do is list out all of your expenses or potential emergencies, even things like getting a flat tire. Write down a rough cost estimate. Add them all up and multiply by how many months you think you want to be prepared for.
Your final amount should be your goal amount set for your account.
Step 4: Contribute
Make automatic payments to your separate savings account. You now need to fund it! Seems scary to fund an account with a number in the thousands, but in reality, if you needed to get to that $12,000 mark, all you have to do is contribute a few hundred dollars each month to build your account. On average, most people need to dip into their emergency fun maybe once a year. After a year or two you might be done funding.
Set up automatic payments because you want to give your money purpose and have it go to work. With automatic payments, you barely see the affect in your account, because as soon as your paycheck comes in, that automatic contribution should be taking it right on out and into that other account.
If you don’t have an emergency account or haven’t thought about having one, follow these steps and open one immediately. Don’t let that emergency hit you before realizing that you needed that cushion of cash. You might think that you can cover yourself when the time comes, but when it does and you have to pay your monthly bills AND extra money to cover the emergency, that is how people start falling into the debt trap.
Note: Most financial advisors would recommend keeping your emergency fund all cash. If you want that money to grow and feel comfortable with your contributions and your karma is good, then try your hand at investing it. Of course, there is always risk, but if you assume that you have a very low likelihood of using the money from your emergency fund, you could invest that money.