The Importance of an Emergency Fund in Your Financial Portfolio
Big expenses have a way of popping up when you least expect them, and for the unprepared, when they least can afford them. An emergency fund can allow you to be prepared and plan for difficult financial periods and unforeseen expenses. One of the biggest benefits of an emergency fund is a lowered stress level, with peace of mind that emergencies can be handled with minimal disruption. If something big pops up, you won’t be homeless and will at least have the protection of some time to pay your bills while you adapt or overcome the emergency. You can avoid the stress of personal loans, high interest credit cards or worst of all, payday loans.
What is an Emergency Fund For?
Your financial goals probably consist of saving for retirement and possibly paying down debt and saving for children’s college expenses. You may be saving for a large expense such as a down payment on a home. Another important piece of any financial plan should be an emergency fund. An emergency fund should be for just that – emergencies. Examples of events for which an emergency fund may be necessary:
Unexpected job loss
Unplanned legal bills
Medical or dental emergency
Unexpected major home repairs (hail damage, flood, fire, etc.)
Unplanned travel due to family needs.
How Much You Should Have an Emergency Fund
A good starter plan for an emergency fund is three months of rent or mortgage payments. For example, if you pay $2,000 in monthly rent, you should aim for a minimum $6,000 emergency fund. Whether you want to save that right away, before prioritizing paying down debt will depend on your goals. You may choose to make minimum payments on loans and credit accounts, while putting aside as much as possible until you reach $1,000. And then make smaller contributions to the emergency fund while paying down debt. If you get paid twice a month, and are able to contribute $125 from each paycheck to building your emergency fund, you will have $6,000 saved in 24 months. This may seem like a lot of money, but you may be able to save it quicker due to gifts or work bonuses. Once you start looking for areas you can save money, and not spend money, you will likely find you can improve upon even ambitious goals.
How quickly you can save your emergency fund will depend on how much money you are able to set aside each pay or income period. If you are on limited income, or paying down significant dept, you will be able to save less and consequently, it will take you longer to set aside money. Even if it takes you awhile, you should plan to consistently save a little each pay period until your emergency fund is reached.
If you don’t save currently, in the beginning, saving money each month might not be easy. Like creating healthy eating habits to lead to weight loss, healthy spending habits aren’t easy at first, and you don’t see results overnight. But by tracking your monthly expenses and bills, creating a budget, and eliminating impulse spending, you can save money and your emergency fund will grow quickly.
Emergency Fund Money vs. Predictable Expenses
If you can avoid it, you should not use your emergency fund money for one-off costs like property tax bills, car registration renewal, or replacing appliances. You know these expenses will come up, and approximately, how much they will cost. Rather than relying on emergency funds, A better strategy is to put aside a little money in savings each month to pay for these expenses when they arise. Put these into your budget and they will truly not be surprise expenses. For example, if you know your car registration will be about $150 every February, setting aside $12.50 each month will allow you to easily set have this money. You might set up a separate high-yield account specifically for these smaller one-off expenses and holiday expenses, and create a spreadsheet or matrix of expected expenses and monthly set-aside amounts. You can further simplify your savings by creating automatic transfers from your checking account a day or two after you get paid. As a bonus, you will earn interest in the money you set aside to savings.
High Yield Savings Accounts
A separate and dedicated savings account is a good option for an emergency fund. With all of the bank options available, paying monthly fees on a savings account, or receiving 0% interest should be avoided. If you want to put money aside and not think about it, online banks such as Ally, Discover, or Marcus by Goldman Sachs are great options. With Ally, you can open and fund a savings account with any amount, even $1.
Green Dot Bank has a competitive savings account option if you open up a checking / debit account. The checking account comes with a free savings account, earning 3% annual interest on your savings. For the Green Dot account, interest is paid on each anniversary based on the average daily balance of the prior 365 days, up to a maximum balance of $10,000 as long as your bank account is in good standing and doesn’t have a negative balance. With any account you are considering, read the fine print carefully in regard to fees and interest rates.
Growing Money Over Time
Once you have set aside your emergency fund, you should keep it wherever you will earn the most interest, while still having accessibility if you need it. You may choose a certificate of deposit accounts to hold emergency fee funds. If you prefer a certificate, no-penalty CD accounts are best, as you should not be penalized for accessing funds when you really need them. The more money you can save, the more interest you will earn. Over time, your emergency fund can grow beyond three months of rent or mortgage to six months. Start with small, achievable savings goals and increase your savings over time!
All information and materials in this article are for educational purposes only. Opinions expressed in this article are based on information considered reliable, but The Daily Money Show cannot guarantee the accuracy of the information nor should it be relied upon. The information discussed in this article should not be used as a recommendation to buy or sell securities nor should it be taken as investment advice. The Daily Money Show is not a Registered Investment Advisor or Broker Dealer. The Daily Money Show is not an accounting firm and does not give tax advice regarding any security or real estate transaction. You may want to consult with an accountant, attorney, real estate agent or financial advisor before proceeding with any transaction regarding securities or real estate.