Will Your Emergency Fund Cover a Real Emergency?

Most Americans are not savers. As of 2019, 40% of the families couldn’t cover a $400 emergency.  For too many people, especially during the pandemic, saving is an impossible dream. How you build an emergency fund when you’re just getting by?

Why Start an Emergency Fund?

An emergency fund is a backup plan.  It’s a savings account people can draw from in event of an emergency. Some emergencies are small – a car repair or replacing a broken phone. But other situations are more dire. A lost job, an unexpected medical bill, a broken water pipe.

If you have credit, that may resolve the immediate problem. But if you have to use a card, you may not have the money for the payments. That starts a downward spiral the damages your credit and makes the situation worse.

It’s far too easy when you have a good job and a decent salary to ignore the need for an emergency fund. It might require a budget or minor lifestyle changes. Less shopping, more saving. But too many people don’t feel a need to save until an emergency hits.

By then, it’s too late.

How Much is Enough?

It’s a common question, but there’s a better one. How much do you have saved?

That number is the baseline for how much you need. (If you haven’t saved anything, consider this a big wake up call.)  Let’s say you’ve saved $1200. Congrats, you’re probably feeling pretty good about that.  That would cover a replacement for your washing machine. The bill for the plumber too.

Check Your Budget (Use a bank statement to get real numbers.)

  • Total one month of salary (salary after taxes.)
  • Add up one month of bills – rent/mortgage, utilities, groceries, transportation.
  • Subtract the monthly salary from the monthly expenses.
  • How long will your $1200 last?

Here’s the calculation: [adjusted monthly expenses-1200]. In this case, a negative number is good. But it’s rare to find monthly living expenses lower than $1200 a month.

Average income and Expenses

According to recent data from the Fool website the “average” annual net income is $67,241. That’s $5,603 per month. The “average” monthly spending is $5,102.  It’s broken out here.

average income and expenses

According to this, average monthly spending is 91% of net income. The $1200 in savings account is just 24% of $5102. That’s 67% short. If you lost your job, it doesn’t even cover a month’s worth of expenses.

Job losses can be sudden – the pandemic has proven that. Many industries have been hit hard, small businesses are barely surviving. It’s difficult to calculate the amount of time it takes to find a new job. The travel and hospitality industries are shedding employees. Essential workers – grocery stores, gas stations, warehouse employees – are still needed. But it’s unlikely that any of them have a net salary of $67,000.

This is why an emergency fund is critical.  Use this calculator to see how much you’d need to stay afloat if you lose your job.

Saving for Emergencies

There are all kinds of methods to increase your savings. The more you can automate it, the better off you are. If you never have access to it, you can’t spend it.  Set up an automatic transfer from your checking to your savings when you get paid. If you can’t do it automatically, the day your check hits, login to your account and transfer it manually.

The 50-30-20 Rule

This is a traditional method that defines how to budget your money. Use 50% of your income for necessities – rent, mortgage, utilities, transportation. Take 30% to spend on non-essentials – the things you want. Finally, put 20% in savings.

If you make $50,000 a year (after taxes) that breaks out to $2500, $1500, and $1000, respectively. If you follow that formula, your emergency fund will cover one month in three months. A smarter choice might be to flip-flop the percentages. If you put 30% into savings, it takes two months to cover one month.

If you want a 3-month emergency fund, you’ll need $7,500. That would be 5 months at a 30% savings rate and 10 months for a 6-month fund.

You may not need $2500 for your living expenses. Anything left over should be shifted to savings. This rule offers a guideline for budgeting. The real value is to see how much and how long it takes to build a substantial emergency fund.

More Cash, Less Plastic

Spending is an addiction in America. The proliferation of cards as opposed to cash is partly to blame. Debit cards make impulse shopping easier. Credit cards can increase the amount you spend by 83%.

Dave Ramsey has long been an advocate of all cash all the time. That’s challenging for many households, but American’s reliance on debt is a serious problem.  If you currently have debt, he suggests an emergency fund of $1000. Get yourself out of debt first and then build your fund.

Ramsey’s thinking about the duration of the emergency fund is financial stability. If you’re in a two-income household, with the same job for years, three months should tide you over. For single-income households, a 6-month emergency fund is a better choice.

How to Save Money for an Emergency Fund

For some people, starting an emergency fund is challenging. Even people with a healthy income have a hard time putting money in a savings account.  Start with a reasonable goal – like enough to cover your rent or mortgage for a month. Two if you can.

Housing is an important bill to pay. Though evictions/foreclosures aren’t allowed during the pandemic, that won’t last forever. If you lose your place to live, trying to get back on your feet will be 100 times harder.

The Purpose is Saving

If you’re not sure how much you spend on what – Nerd Wallet offers an app to track it. There are some add-ons, the app will monitor your credit and offer insights on how to meet your goals. If you’re not sure where to start, this might help you target opportunities to save.

You can reduce some of your living expenses, but don’t lose sight of the goal. It’s not enough to make changes in your spending. You need a plan to get the money you saved into a savings account. For each reduction you make, you need the amount you were paying and the amount you save.

Let’s say you spend $50 a week buying lunch – $10 a day. You decide to bring your lunch 3 times a week. That means $30 a week – $120 a month – needs to go into savings. As we recommended before, set up an automatic transfer weekly or monthly from checking to savings.

If you use cash to pay for your lunch, take the $30 out of your wallet. Take the money to the bank weekly or biweekly.  Or only take $20 from your checking account and transfer the money to savings.

 change jars full of coins

1. Save Your Change

Change jars are a constant, pennies, quarters, dimes, and nickels piling up. If you use cash, you can watch the money pile up. Once a month, put the coins in your savings account. If you can try the Mason Jar Money Method to save $1300 in a year.

But if you don’t use cash, the change jar stays empty.  Mobile bank Chime has an app with a virtual change jar. They round up your debit transactions and transfer the difference to your savings account. You can also set up an automatic transfer of 10% from your paycheck to your saving account.

2. Refinance What You Can

Take a look at the loan payments you have – mortgage and auto. Depending on your credit, there plenty of options to reduce your payments.  For your mortgage, use this refinance calculator to see your best options. Depending on your equity, may it be possible to remove private mortgage insurance.

If you want to refinance an auto loan, you need a good credit score and payment history. Review your current loan terms, then shop around. Bankrate has some loan providers and interest rates for refinancing.  Be aware some lenders have refinance limitations based on age and mileage.

If your current loan is close to completion, it’s better to pay it off. When it’s done, you can direct the payment to your emergency fund.

Student loans are a whole other animal. If you have a government loan, the best you can do is extend the term of your loan. That reduces your current payment but extends the interest you pay. Private loans can be refinanced. If you have multiple loans you can roll them into one and hopefully get a better rate. Lenders check your credit, but also consider your income potential.

3. Make it Harder to Shop

The average American credit card balance is $6,194, with a minimum payment of $123.88. A minimum payment does nothing to knock down your principal. The more debt you rack up, the harder it is to pay off.

When you head out, take your credit cards out of your wallet. Use your checking account. That will slow down impulse buys. Take a look at what you’re spending on your cards. Set a goal to reduce your spending by 10% to 20%. Calculate the amount and transfer the difference to your savings account.

If you shop online, don’t save your payment information. One-click buys are the easiest way to spend too much. Take a look at what your spending, especially given the shutdowns during the pandemic. Though not a direct route to building your emergency fund, reducing your spending means money to save.

4. Take a Look at your Phone plan

First, hold on to your current phone for at least 2 years. Newer versions of phones are produced to convince you need to spend $600 for a few more camera pixels.  Put that money in your savings instead.

No contract phones are cheaper than brand name plans. They run off the same network, so the service quality is the same. At Straight Talk, an unlimited plan with 25 gigs of data is $45 a month. (You can bring your GMA phone and swap out the SIM card.) Unlimited at ATT starts at $75.

New providers like Mint Mobile are offering great deals on service – starting at $15 a month.

5. Use a High Yield Saving Account

Once you start saving, look for the best ways to grow your money. Putting money under your mattress is just one step from a traditional savings account. High-yield savings accounts offer a higher interest rate and APY.

This list of high yield saving accounts offers an APY up to .81%. The standard interest rate from most big banks is .01%. Online banks offer higher interest rates than brick and mortar rates.  You can set up a savings account online and still keep your current bank.

It’s important to understand that your emergency fund has to be liquid. If you stick money in CDs or bonds that haven’t vested, you lose money.

Define Emergency Fund

Once you’ve saved some money, it’s tempting. All that money just sitting there when there’s a great deal on a fishing boat.  You want it, want it bad. There won’t another one at this price EVER!

Step away from the ATM. If you think back to the 50/30/20 rule, this falls in the 30%. If you can’t do it without dipping into your savings – it’s not an emergency. It may feel like an emergency, but feelings aren’t facts.

The money you’ve put away is for unanticipated expenditures. A medical bill. A leaky roof. A job loss. If you can pay for smaller items like a replacement phone or minor auto repair from your checking. Leave your emergency fund for when you need it.

If an emergency hits, you’ll be grateful you did.

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