How a 6-Month Emergency Fund Can Save You From Financial Crisis
Don’t you wish you had a safety net that would shield you from life’s curveballs? Or that could turn a major crisis into a minor inconvenience? Even if your heat went out in January, you’d be fine. How is this possible? With a six-month emergency fund!
What exactly is an emergency fund? Let’s take a look…
What Is an Emergency Fund?
An emergency fund is money you set aside for unexpected expenses. This is a crucial part of financial planning.
This money serves as a safety net during a financial crisis. You can use it if you lose your job, get a surprise medical bill, or have a major auto or home repair. Think of it as a line of defense for your finances.
Benefits of an Emergency Fund
Having an emergency fund will give you some financial security. You can protect your wallet, investments and credit with it. Americans have learned from the recent recession how important it is to save. It’s impossible to predict when a financial crisis will strike…
A 2015 study conducted by The Pew Charitable Trusts found that 60% of households had experienced a financial shock in the prior 12 months. It also found that of the more than 7,800 households studied…
More than half of households struggled to “make ends meet” after their most expensive financial shocks. Nearly 50% still had not recovered at the time of the survey, which for most was at least six months after their destabilizing shock.
Now that we’ve covered the importance of an emergency fund, let’s find out how long you should prepare for…
The Golden Rule: Six-Month Emergency Fund
To play it on the safe side, it’s good to have a six-month emergency fund. To find out how much you need, you can take a closer look at your living expenses.
Most households have a set of fixed costs each month. This allows them to maintain a consistent budget.
Common living expenses include…
- Debt payments.
You don’t need to include expenses that fall outside of your needs. You can always cut them out if you’re having a hard time. Here are some examples of expenses you don’t need for your six-month emergency fund…
- Nonessential shopping
- Dining out
A few small changes, such as eating out less and cutting down on cable subscriptions, can help you save money.
How to Calculate a Six-Month Emergency Fund
Adding up your monthly living expenses will give you an idea of how much you need to save for an emergency fund. Multiply those amounts by six.
As an example, if a family requires $2,500 per month to cover essential living costs, it should aim to save $15,000 to have a stable six-month emergency fund.
Here’s a better breakdown of the process…
1. Begin by Adding Up Your Monthly Expenses
- Rent or mortgage payments
- Grocery spending
- Utility payments (gas, electric, water and garbage)
- Transportation costs (car payment, gas and public transit)
- Insurance for your car, health and home
- Credit card and loan debt payments
- Telecom services
2. Set a Monthly Savings Goal to Put Away for Your Emergency Fund
You may think saving six months’ worth of expenses is impossible… But you can achieve this easily by putting money aside consistently. If you saved $250 per month, you would have $3,000 after one year.
Once you have calculated the amount you need for a six-month emergency fund, set a goal to save a set amount of money each month for your emergency fund. Get in the habit of putting money into your account on the same date every month.
3. Evaluate and Assess Your Savings
Track your emergency fund throughout the year. Check your progress and adjust your savings if necessary. If you pulled some money from the fund recently to cover a big expense, think about saving more to make up for it.
You can increase your funds by reducing unnecessary expenses and reinvesting the extra cash. Americans rarely seek out simple ways to cut their expenses. By learning about cost reduction strategies, you can save thousands of dollars.
Where Should You Put the Emergency Fund?
You should use this money only in an emergency. Because emergencies tend to come without notice, it’s good to use a liquid bank account or investment to hold your funds. This will allow you to access the money quickly without causing any big changes in its value or incurring any added losses. High yield savings accounts and money market accounts are both suitable choices.
High Yield Savings Account
These accounts offer a higher annual percentage yield on deposits than traditional savings accounts do. In the long run, your money will earn more interest this way. High yield savings accounts can also carry fewer fees than traditional savings accounts. By choosing the right account, you won’t have to worry about minimum balances or maintenance fees.
Online high yield savings accounts are popular, but you can also get them at a brick-and-mortar bank. Many people prefer the online method because of the convenience of online banking. Here are some of the best online savings accounts.
Money Market Account
A money market account is a savings account with added features. Depending on your account, you may be able to get a checkbook or a debit card that allows for a limited number of transactions each month. If you need to access your funds as soon as possible in an emergency, this can be helpful.
The downside to this account is that it might require a higher minimum deposit than a savings account. It also might cost more money to open than most savings accounts. A money market account may not be for you until you can increase the size of your emergency fund.
Some people prefer money market accounts because they allow easy access to their funds. You can learn more about a money market account here.
Start Building Your Six-Month Emergency Fund Today
It takes time to build an emergency fund, but having one is an important part of a stable financial plan. Many Americans don’t have an emergency fund. However, not preparing for life’s inevitable emergencies can leave you in a bind. You can protect yourself and your loved ones by building up a six-month emergency fund.
If you’d like to learn more about saving and investing, consider signing up for Liberty Through Wealth below. It’s a free e-letter that’s packed with investing insight. Whether you’re a beginner or an experienced investor, there’s something for you.
About Aimee Bohn
Aimee Bohn graduated from the College of Business and Economics at Towson University. Her background in marketing research helps her uncover valuable trends. Researching IPOs and other trends has been her primary focus over the past year. When Aimee isn’t writing for Investment U, you can usually find her doing graphic design or traveling with friends.