Saving money is the most important financial discipline to master. The reason for this is due to its necessity. It's imperative you build wealth so you won't have to rely on debt to get you through rough financial patches. One of the most effective ways to do this is by the use of an emergency fund. Here's a closer look at what an emergency fund entails, why it's necessary and ways to start one.
Defining an emergency fund
Simply, an emergency fund is money you set aside - typically in a savings account - that you use solely for financial emergencies. You earmark this money to account for the unexpected. As such, this is a hands-off account, meaning the only time you'll want to withdraw funds from it is when you need the cash and don't have other means to obtain it.
The necessity of an emergency fund
There are many instances where life can throw you a financial curve ball, and you need money saved to account for it. Here are some illustrations of why you need an emergency fund:
- You receive a job offer out of state and need money to move
- Your car breaks down, resulting in a large repair bill
- Your home's water heater broke
- Family emergencies where you have to travel out of town immediately or they need help financially
- Loss of income
What you'll notice about these illustrations are they can happen to anyone at anytime. Because of the unexpected nature of life, it's vital you have the financial resources to account for it. Sure, you could use credit cards to bail you out in some of these situations, but this will result in more debt, and the longer you pay on those debts, the less you'll be able to save over your lifetime. Therefore, it's important to take a long-term approach when making financial decisions; this is why having an emergency savings account is so important.
How much should I save?
Once you are ready to open a savings account for emergency purposes, it's important to designate a savings goal, as this will keep you focused on socking money away. Financial expert Dave Ramsey recommends a savings baseline of $1,000. With this, you'll be able to account for many unexpected expenses that could arise.
It's important to note the $1,000 is the minimum you want to save. Ideally, you should aim to save anywhere between three to six months of living expenses, that way if something big were to happen such as a job loss, you would be covered during that time and not have to rely on credit cards or personal loans. However, before aiming to save a larger amount, Ramsey recommends using his Debt Snowball Plan to eliminate debt first. That way you have those financial obligations gone and can focus entirely on saving money.
Once you pay off debt, it's important to come up with a figure that aligns with your finances. A good way to do this is to calculate your living expenses for one month. This should include necessities such as rent/mortgage, utilities, your debt obligations such as credit cards, car and personal loans and other financial requirements. You'll also want to create averages on how much you spend at the grocery store, for gas, etc. By compiling a monthly total, it gives you an idea of how much you need to save. For example, if your monthly living expenses are $1,500, and you want to have six months worth in the bank, your savings goal would be $9,000. That might seem like a steep goal, but with careful planning, you can get there. Here's how you get started building an emergency savings account.
The basics of building an emergency savings account
The first step is to analyze your budget and look for ways to reduce unnecessary expenditures. If this means forgoing a newer car or eliminating cable, so be it. In addition, you want to identify ways to reduce expenses you have to make. It's important to comparison shop to ensure you are receiving the best rates on your insurance and credit cards. By comparing, it gives you leverage that you can use when speaking with your providers, who in turn, could give you more competitive rates or premiums.
Once you maximize your savings potential, you'll want to open a high-yield savings account online. Online savings accounts are the best option for a variety of reasons. For starters, they offer more competitive saving yields - the amount of money you earn - than with your traditional bank or credit union.
Online banks also don't charge as much in fees, so there's no need to worry about your savings balance reducing each month due to a maintenance charge. Lastly, online accounts make it harder for you to access your money. While many savings accounts - even online ones - give you the option to have an ATM card, you can decline it. The goal is when you set this up to leave the funds alone unless you have to have them for an emergency purpose. Therefore, find an online bank with great saving rates, no monthly account fees and open an account with them.
After opening your savings account, you'll want to develop a regular stream of deposits into it. An easy way to achieve this is to set up regular transfers from your personal checking account to your online savings account, which your financial institution allows you to do for free.
The best recommendation is to set up transfers on your paydays, that way you pay yourself first before paying other bills. You can do this by designating a specific amount to transfer for over during each payday, normally specified in weekly, biweekly or monthly intervals. Moreover, once you set this automatic transfer up, you won't have to worry about it again, as the bank will do the work for you. You can sit back and watch your emergency savings account continue to build towards your goal.
Saving Tricks to Keep in Mind
It's important to keep tabs on your finances regularly. Once a month you should examine your bank statement to ensure you're meeting all your goals. Not only will this help you stay on track with savings, but it also ensures you're making all your payments on time and you're keeping a firm grasp on your spending behaviors.
Another good tip is to find someone you know who is good with money and have frank conversations with them about your personal finance goals. They can offer helpful insights into how they built financial success. They can also serve as accountability partners to ensure you are adhering to your saving goals. If you don't know anyone, a personal banker at a local financial institution or a reputable consumer credit counseling agency would also work.
Lastly, remember to balance savings with paying down debt. As noted above, once you establish a baseline for savings - $1,000 - then knock out your debt next before proceeding. The reason for this is the faster you pay off debt the more money you'll save. Once you are debt free, you can turn your attention back towards saving, and now that six months savings goal doesn't seem so formidable because you have the freedom to reach it.