What do car accidents, house fires and layoffs all have in common? They’re all unexpected, uncontrollable and urgent life events that occur in our world every day. What you can control about these situations is the emergency money you save to prevent these situations from having a negative impact on your financial status.
An emergency fund is a safety net that can help cover unexpected expenses without breaking your budget or taking on debt. Emergency savings are meant to be kept separate from your other long-term savings goals and only used in case of emergencies. Consider these tips from Dutch Point Credit Union to help you build your emergency savings fund.
Budgeting for an Emergency Fund
According to The Federal Reserve Bank, four out of 10 Americans don’t have the funds to cover a $400 emergency expense. Setting aside cash for unexpected events is important for long term stability and can also give you some peace of mind, considering how unexpected life can be.
The rule of thumb is to save at least three to six months of living expenses in an emergency savings fund. The amount of emergency cash you should budget for depends on your lifestyle, committed expenses, household size and income.
Here’s a simple way to figure out how much emergency money you should budget.
Step 1: Figure out the total necessary expenses you pay each month
These expenses include everything from your rent or a mortgage payment, utilities, car payments, gas, groceries, phone bill and any other necessary payments made on a monthly basis. For this example, we are going to assume $2,000 a month of expenses.
Step 2: Pick the number of months you would like this emergency fund to cover
Although it’s recommended to save enough to cover at least six months’ worth of expenses, we’re going to use three months for this exercise.
Step 3: Choose how long it will take to fund an emergency savings account
This number is based on the amount of money you intend to save per month. For this example, let’s say we want to reach our emergency savings goal in three years.
Step 4: Do the math
- Multiply monthly expenses by the number of months the emergency fund will cover.
$2,000 x 3 = $6,000 emergency cash needed
- Multiply the number of years you’ll save to reach your emergency savings goal by 12, to figure out the number of months you’ll need to fund the emergency account.
3 x 12 = 36 months to fund savings goal
- Divide the emergency savings goal by the number of months needed to fund your savings goals to determine your monthly contribution.
$6,000 / 36 = $167 monthly contribution
In this example, you need to save $167 every month for three years to have $6,000 in the emergency savings. This doesn’t account for any interest accrued from your savings account.
Where to Stash Your Emergency Cash
Now that you know how much money you need to save to build up your emergency savings, now you’ll want to decide where to save it. It’s smart to start a separate account for your emergency fund to avoid the temptation of dipping into it. Here are a few safe options for storing emergency money.
- Special Purpose Savings Account: This type of savings account will allow you to access your money easily in case of an emergency and offers a competitive dividend rate. It's also a little less tempting to use money in a special purpose savings account because it's not linked to your debit card.
- Money Market Account: This type of savings account is appealing because you gain access to higher dividend rates than special purpose savings accounts, plus your rate can increase as your balance increases. You can enjoy access to funds when you need them because your money stays liquid and available to you.
- Certificates: Another option is to invest some of your emergency savings into a certificate as a way to earn interest on money you’ve already saved and can afford not to access for a while. You’ll get a guaranteed rate of return based on your initial deposit and term selected. You may also consider laddering certificates so they mature at different times, giving you access to your money at various intervals.
These options will allow you to remove yourself completely from this fund, as it is only meant for emergencies. If this fund ends up being used for recreational purchases, such as vacations or new cars, you will no longer be protecting your finances for emergencies.
Emergency Savings Strategies
Depending on your situation, it may be difficult to set aside money into an emergency savings account. Here are a few strategies to help you save more for a rainy day.
- Make savings automatic: Use direct deposit to automatically set aside a portion of your paycheck into your special purpose savings account or money market account each month.
- Evaluate and reduce monthly expenses: Look at non-essential costs that can be substituted with less expensive alternatives or cut out completely. If you tend to buy coffee every morning, try making coffee at home or wait to drink the coffee at work. Take a look at subscriptions that may be non-essential or try cooking more at home and eating out less. Your emergency savings account will thank you later.
- Sell used items: If you haven’t used something for six months, why not sell it? There are free apps and websites that help you sell unwanted items for cash. You could also have a good old-fashioned garage sale. Set aside the money you make into your emergency account.
- Look for additional income: Have a talent that could be profitable, or have free time on your hands? Make some extra money by getting a second job, help out family, friends and neighbors by completing odd jobs for cash, or start making and selling items online.
- Re-calculate your budget each year: Expenses and circumstances change in life, so make it an annual task to ensure you’re saving the right amount. Our savings goal calculator can help you determine how long it will take to reach your savings goals as your budget changes.
A fully funded emergency savings account gives you the ability to deal with problems in a level-headed manner and helps you avoid high-interest loans (like payday loans) or racking up credit card debt. This approach will enhance your lifestyle both financially and emotionally, giving you peace of mind during the times you need it the most. Contact a Dutch Point Credit Union account specialist for advice on the best savings accounts for your emergency fund.