Life is unpredictable. You could lose your job tomorrow or your car could require a very pricey repair next week. While there’s nothing you can do to stop these unpleasant surprises, you can make sure you’re financially prepared to meet any challenge that comes your way. Make setting up an emergency fund one of your financial goals for 2014.
Ideally, you should have an emergency fund containing at least three to six months of living expenses. This allows you to pay unexpected bills, instead of racking up credit card debt or taking out high-interest loans. If you’re just starting to save, don’t feel overwhelmed. There’s no need to put aside all the money at once. Aiming to save 10 percent of each paycheck is a great way to get started.
How Much Should You Save?
While experts recommend saving three to six months of living expenses, the exact dollar amount will vary based on your spending habits. Consider the fixed bills you pay on a monthly basis, including your rent or mortgage, utilities, loan payments and health or auto insurance. You should also be sure to consider:
- Groceries. You’ll always need to eat, but some weeks, your bill totals more than others. If possible, determine an average figure from your bills during the last year.
- Gas and other transportation costs. This could also include items like occasional bus fare or transit passes. Again, determining an average monthly figure from your past year’s bills might be helpful.
- Small indulgences. If you’d rather not give up Netflix or Hulu Plus – after all, they represent a huge savings, compared to cable – be sure to include them, or other indulgences you think you can manage.
On the other hand, feel free to exclude expenses you could and would do without in an emergency, including any money you spend on new clothes, meals at restaurants or vacations. If you’d feel comfortable canceling your cable subscription or gym membership, you can leave those out, too.
How Should You Save?
If you’re living paycheck-to-paycheck, the idea of finding money in your budget to put toward an emergency fund may seem out of the question. However, you’d be surprised at what you can do with a little planning.
- Start with your tax refund. Jumpstart your emergency fund by depositing your tax refund, or any unexpected cash you receive. If you receive checks from relatives for your birthday or holidays, put them in the fund.
- Save loose change. No one likes to carry around change. Take whatever is in your pockets at the end of the day and put it in a jar; at the end of the month, save the contents of the jar. You can do this with checks and debit card transactions, too, by rounding them up to the next dollar when you record them.
- Cut back. Could you save on your daily coffee by investing in a new coffeemaker? Avoid buying your favorite magazine or newspaper each week by reading it online? If you can find any ways to save money in your routine, you can put that savings in your emergency fund.
- Even if you have money to spare, it takes willpower to deposit it in your emergency fund. If it’s easier, try setting up automatic withdrawals from your checking account every month or pay period.
Where Should You Save?
But where should those automatic withdrawals go? Emergency cash should be in a fund that’s both low-risk and easily accessible at a moment’s notice. Ideally, you should have a checkbook or debit card for the account. A checking account that is separate from your daily checking account or a savings account specifically designated for emergencies are two good options. The checking account offers easy accessibility, while the savings account provides interest rates on your money, offering an additional way to grow your emergency fund.
The Bottom Line
It’s hard to overestimate the importance of an emergency fund. And if you think you should start one only after you’ve paid down your current debts, think again. If you put all of your extra cash toward debt repayment, you may end up right back where you started – or worse, if you’re faced with an unanticipated expense. Paying off debt is a great goal, but it shouldn’t be your only goal. Being prepared for financial surprises is a great way to help yourself and your family.
Alice Holbrook, NerdWallet