A recent study found that 57 percent of Americans have less than $1,000 in savings, while 69 percent have less than $5,000. That’s not enough to get you through an emergency. Here’s how to build an emergency savings fund.
Emergency savings promote financial well-being
No one knows for certain what tomorrow will bring. But we can control our financial decisions today. By definition, emergencies are unforeseen events. An emergency savings fund allows you to absorb financial shock without sacrificing long-term financial goals. An emergency fund (or “rainy day” savings account) promotes financial well-being, even if it seems far-fetched to those who don’t make a whole lot of money.
Unexpected unemployed, medical emergencies, or urgent home repairs can quickly turn into moments of crisis. How well-prepared you are for life’s shocks promotes financial well-being in your entire life, not just during emergencies.
Pay yourself first
The idea that you should pay yourself first simplifies the process and reduces the hassle of saving. Try to keep the savings process as simple as possible.
Open up a separate savings account and make an initial deposit. Then contact your HR department and allocate an amount of your paycheck directly to that account. In this way, you ensure that you pay something every pay period into your emergency savings.
How much you save depends upon your individual circumstances. But save something. Your goal should be to save up to six months of monthly living expenses, even if it may take many months to achieve that goal.
Retirement funds are NOT emergency savings
When facing an emergency, you may be able to take a loan out against your retirement savings. This solution is not recommended for several reasons.
First, you will need to either pay back that loan or pay enormous early withdrawal fees and taxes. Second, retirement savings are for your retirement, not for emergencies. And third, while you are repaying your retirement fund, you will not have that extra cash to pay toward other types of financial goals, including emergency savings.
Of course, it is also rarely wise to tap retirement savings to pay existing debts.
Overcoming obstacles to building an emergency savings fund
Financial advice is often perceived as something to aspire to but not necessarily act upon. It can be difficult to save when you’re living paycheck to paycheck. An emergency savings fund is more important than other types of financial vehicles because emergencies inevitably happen. The ability to withstand financial hardship often depends largely on whether or not you’ve saved enough to get you through that hardship.
Saving requires discipline. Financial rules cannot be applied equally to every person at every income level. Instead, set a realistic goal, even if it’s just $100 a month. After a year, you’ll have more in savings than more than half of all Americans.
But don’t stop there. Once you have your savings allocation set up, just forget about it. Resist the urge to tap those savings or loosely define an emergency. Once you’ve saved six months of expenses for your emergency fund, then you can give yourself a raise and allocate your automatic savings budget toward another goal, like retirement.