Have you ever had the small misfortune to wake up, take a shower, but have no hot water, or where you’re driving to work, only to get a flat. You hope these problems are just a quick fix. But when they’re not, you know it’s going to cost more than you want to spend. The good news is you have an emergency fund set aside just for these situations, right.
When these unplanned problems show up, it’s easy to turn to a credit card and slowly pay it off each month until the next big surprise happens. Of course paying off the extra debt won’t be fun and if it piles up too high, credit cards no longer become an option when the water heater craps out or worse, there’s a job loss.
How Much Should Be Save?
Financial experts give a wide range for how much should be saved for an emergency fund. A starting point is 4 to 6 months of basic expenses. With the recent recession, some experts go as far out as 9 to 12 months. Which may be a bit excessive.
The first step is figuring out your basic expenses. If you have a budget this should be pretty easy. If not you want to add together a few of your monthly costs:
- mortgage or rent
- car payments
- average utility, phone, cable bills
- insurance (health, dental, home, car, life, etc.) costs
- monthly food expense
- any other expenses that you absolutely can’t live without
Once you have your basic expenses figured, it’s time to start saving. The key is to start small. Work on saving one months worth of expenses or up to a fixed amount like $500. When you reach that goal, start over and do it again until you’ve built up a comfortable amount.
You Won’t Spend What You Don’t See
Automating your savings is something that has been going on since direct deposit. Most banks offer free automatic transfers between bank accounts. If you’re the type who will spend what you see, try using an online bank to save. Just make sure the account is one-way. You don’t want to be accessing your emergency fund account with a debit or atm card and spending it on the weekends.
Keep The Savings Simple
If you have enough saved to meet minimum deposit requirements, get the money into a high yield savings, money market, or no-penalty CD account. The interest rates may not seem like much, but you might as well earn some money on your hard earned savings.
I don’t recommend other investments until you have a nice cash cushion of about 4 months of expenses and even then any investment should be very conservative. Stocks and bonds can go down in value just as unexpectedly as an emergency expense showing up. Dealing with both happening at the same time defeats the purpose of having an emergency fund entirely. For most people it’s not worth the risk.
If you don’t have an emergency fund, there’s no need to panic, yet. Saving for one can be easy if you budget for it. Building an emergency fund doesn’t happen over night. It may take a few years to buildup a comfortable amount. When your next surprise expense shows up, you’ll be happy you did.