Save Some for a Rainy Day: Creating the Perfect Emergency Fund
No one wants to think about needing to dip into a source of emergency cash, but it's important to understand that you might need one, and to plan accordingly. Whether it's a health emergency, loss of employment or other unexpected misfortune, a financial crisis can happen to anyone and if it does, you'll be glad you've socked some money away. Below: all your questions about an emergency fund and how to start one, answered.
How much is enough?
It's recommended that you save up about six to nine months' worth of income in case of a financial emergency. If your job is unstable or you freelance for a living, it's a good idea to save even more than that. That means if you need $3,000 to pay bills and buy groceries each month, you should have $18,000 saved up—at the very least. A 2011 study conducted by the National Foundation for Credit Counseling found that 64% of Americans have less than $1,000 saved up in emergency funds—making them one crisis away from financial catastrophe.
What counts as an emergency?
A financial emergency is an unpredictable life event that could put you into debt: the car breaks down, you lose your job, your child has a medical emergency, your AC breaks down in 100 degree weather, travel expenses for a family emergency—these are good reasons to dip into your rainy day fund. That killer pair of designer stilettos? A last minute vacation to the Caribbean? Sorry, not an emergency.
I don't have any money saved for an emergency. How can I start?
It's not a bad idea to split your income according to the 50/30/20 rule. 50% or less of your monthly income should go toward essentials: rent, utilities, groceries, and transportation to and from work. 30% or less should go toward lifestyle expenses like shopping, dining out and entertainment. 20% or more should go toward financial priorities: paying off debt and saving. Set aside a little of that 20% chunk each month to go into your emergency fund: even $10 counts!
I don't think I'll ever have the discipline to grow that fund every month!
The solution to this issue is to automate your contributions. Automatic transfers from your checking to your savings account will take temptation out of the equation. Alternatively, ask your employer to directly deposit your chosen amount into your savings so the money never hits your checking account and tempts you to buy you a pricey new outfit or restaurant meal.
If I'm only putting $10 away each month, it'll take forever to add up! How can I grow my emergency fund faster?
There are several ways to save faster if you get creative, and they're the same no matter what financial goals you have in mind.
Before you cut out the small thing you enjoy, take a look at your big monthly expenses, especially your mortgage, auto loan, or credit cards. You may be able to refinance them to save big money on interest and drastically cut the fees you're paying. Even with less than perfect credit, you could save hundreds or thousands of dollars in a year and put that money right into your rainy day fund.
Sara Collins is a writer for NerdWallet, a personal finance website dedicated to helping readers get the most out of prepaid tuition and college savings plans.