Budgeting & Savings
How to Build an Emergency
To quote the American poet Henry Wadsworth Longfellow, "Into each
life some rain must fall/Some days must be dark and dreary." To deal
with those dark days, having an emergency fund is a necessity. Think of it as a shock absorber for the bumps of life, one that'll keep you from adding to the load of debt
you doubtless already carry. Here we look at how much you'll need to
save for your emergency fund and how you can get started, today.
Tutorial: All About Banking
What Will You Need?
While some call having one to two months' wages in reserve ideal,
most fnancial experts recommend that people maintain an emergency cash reserve large enough to cover three to six months' worth of household expenses.
That's a great idea, but it also requires some effort to achieve. The
first step in the process is to figure out how much you spend each
month. Consumer expenditure statistics from the U.S. Department of Labor indicate
that the average annual expenditure per consumer unit, which is similar
to a household, is $57,311, as of 2016 (the most recent year for which
data is available). This data is broken down by month in the table
below. The months in bold highlight the cumulative quarterly expenses,
and therefore, the recommended cash reserve for the average household.
| Number of Months | Cumulative Expenses |
| 1 | $4,775.92 |
| 2 | $9,551.83 |
| 3 | $14,327.75 |
| 4 | $19,103.68 |
| 5 | $23,879.60 |
| 6 | $28,655.52 |
Source: Based on average annual expenditure figure from the Bureau of Labor's Statistics' Consumer Expenditures--2016 release
While your household expenses may be higher or lower than the
average, there's no doubt that even three months' worth of expenses is a
big number. One look at that number and the average person's first
reaction is, "I can't come up with that kind of money."
Why So Much?
The amount of money required to fund a proper emergency fund is
certainly significant, but we live in uncertain times with uncertain economies. Corporate loyalty is a thing of the past and unemployment can
happen unexpectedly, usually at the worst possible moment. Likewise,
emergencies like sudden illness or disability, major car repairs or a
new roof, can be expensive and there's never a good time for these
things to happen.
While it's probably true that you don't have an extra $14,327.75
lying around, everything is relative. Even six months' worth of expenses
is a puny number compared to the amount you will need to save for retirement;
there's not a savvy investor out there who balks at the idea of
stashing away so much money that he or she will never need to work
again. When compared to what you'll need over the course of 20 or 30
years in retirement, three months' worth of expenses doesn't look like
much.
Crunching the Numbers
Now that you have things in perspective, it's time to start saving.
Approach this effort the same way you would approach any other financial
goal. Put together a plan and execute it. The first step is to
determine how much you spend each month. Housing, transportation and
food will likely be the categories that eat up most of your cash. The
average household spends nearly 60% of its income (which
averages $74,664 before taxes, according to the BLS Consumer
Expenditures report), on these items.
Once you know your total expenses for each month, multiply that
number by three. Reaching that number will be your initial goal. To
achieve your three-month target, you need to start saving money.
If we assume your initial goal is $10,000, the table below
illustrates how much you will need to save each month, over a five-year
or a 2.5-year period.
| 5-Year Plan | Amount Needed per Month | 2.5-Year Plan | Amount Needed per Month |
| 60 months | $166.67 | 30 months | $333.33 |
Putting Your Plan into Action
Buying a less expensive car, the next time you are shopping for an
auto, and downgrading your cell phone service are two easy ways to come
up with some cash to fund your savings plan. Skipping that two-week
vacation, cutting down on the amount you spend dining out, and saving
your next raise or bonus are also simple methods of adding to your emergency fund.
The key is to add to the emergency fund at regular intervals. Ideally, you should treat your it like any other recurring
bill that you must pay each month. Dedicate the appropriate amount from
your paycheck and set it aside. While most people have no qualms about
regularly sending enormous amounts of money to credit card companies, they balk at the idea of paying themselves first. Change that equation.
If you are among the many investors
who don't have a rainy day fund stashed away in case of emergencies,
there's no time like the present to start saving. Even if you don't have
the dedication to address the project with a dedicated savings program,
you can start simple: Take the change out of your pockets at the end of
the day and put it in a jar. You could also eat at home instead of
dining out and "tip" yourself by adding a few bucks to your emergency
fund. If you get cash back
on your credit cards, or just paid off a big debt, such as a personal
loan or an automobile, put that newfound money into your fund. If you
get a tax refund,
deposit the check into your fund. If you manage to dedicate just $5 per
day to your effort (less than the cost of lunch!), you'll have $1,825
at the end of the year; that's $9,125 in just five years.
Money market funds or high-interest savings accounts
are good places to park your emergency fund: They'll make it harder for
you to dip into it (face it: you'll be tempted to from time to time)
and you'll earn a bit of return on the money, too.
The Bottom Line
View your emergency fund like an insurance policy. Once you have it, guard it carefully. It's not a piggy bank; you should not using it for incidental expenses. In fact, as your salary rises, be sure to up the amount to match your new situation.
Use the fund only in the event of an emergency and hope that
emergency never happens. Remember, once that money is spent it always
much longer than anticipated to replace it. Start now and save whatever
you can, even if it isn't much. Some day, when you need the money,
you'll be glad you did. You'll be able to weather those rainy days,
without running up a credit card balance or taking out a personal loan.
For more personal finance tips, see Top 7 Most Common Financial Mistakes and The Indiana Jones Guide To Getting Ahead.
:max_bytes(150000):strip_icc()/calculate-5bfc2da246e0fb002601d357.jpg)
:max_bytes(150000):strip_icc()/iStock-653478244.millennial.computer.cropped-0f8d14c0a33d4c2c94dacbcd2ac5855e.jpg)
:max_bytes(150000):strip_icc()/debt_folder-5bfc2fbf46e0fb0051459acf.jpg)
:max_bytes(150000):strip_icc()/EmergencyFund-5bfc2d7cc9e77c00519afccd.jpg)
:max_bytes(150000):strip_icc()/rainy_day-5bfc36bdc9e77c00519d3685.jpg)
:max_bytes(150000):strip_icc()/thinkstockphotos-479705383-5bfc34ce46e0fb0051bf93db.jpg)
No comments:
Post a Comment