MoneyTalk: Building An Emergency Fund

If there is a financial emergency, do you have money saved up to handle this emergency? Or would you need to borrow money by using credit cards to address this emergency?

Life is unpredictable, and you never know when you would be dealing with an emergency. One fine day your car refuses to start and you may need to take it to a mechanic who quotes a big amount to fix your car. Or there is unexpected water leakage in your house and you need to get it fixed at the earliest, but the plumber has quoted a very high price.

Would you have money set aside to address these sudden situations or would you have to put this expense on a credit card, and then pay off that credit card in the future?

According to a report from the Federal Reserve, more than 40% of American adults say they cannot cover an unexpected $400 expense without borrowing money or selling something.

When you use credit cards, you are essentially taking on debt by borrowing money from those credit card companies. It’s great if you can pay off this loan quickly. However, if you are going to be paying only a minimum required monthly payment to this credit card company, you will be paying interest on these loans. And depending on your financial situation and plans to pay off this credit card debt, you may end up paying much more back for using the funds that you had originally borrowed.

 
One of the best things you can do for your financial well-being is to establish an emergency fund. This fund will help you cover unexpected costs in the event that something unexpected happens, like a job loss or a medical emergency. If you plan to become money smart and want to set up yourself for financial success, you should seriously create an emergency fund to address such situations.

An emergency fund is basically a fund where you have been diligently saving money each month and adding to that fund bit by bit so that you don’t need to borrow money and you can stay debt-free. As a rule of thumb, you should save enough money to cover at least three months of your living expenses.

Let’s discuss some of the ways you can start building an emergency fund.

1. Do a Financial Reality Check 

This is an important first step in this process. You need to first look at your bank accounts and see how much money you really have available if there would be an emergency situation today. Now, this amount could vary depending on the situation. If you need to hire a plumber to fix something in your house, maybe you need around $500 to $1,000. But, if you were to suffer a job loss, you will need enough money to help you meet your living needs for a few months or at least until you find a new job. This money requirement could be anywhere from $2,000 to $10,000 or even more depending on your monthly living expenses. If you are in a relationship, then you should work with your spouse or partner and jointly do a financial reality check so that you both can be on the same page. We recommend that you use MoneyPatrol for this exercise. Once you do this evaluation, you can come up with the amount you need to keep aside for your emergency fund and then start creating a plan for achieving this goal.

2. Create a Purpose for Your Emergency Fund 

In the previous step, we talked about how the amount you need depends on the situation that you may have to deal with. When planning, you should know precisely what you are going to use your emergency fund for. You can create multiple categories within your overall emergency fund so that you know how much amount you need for a car repair, house repair or medical needs or to deal with a job loss. This categorization will help you stay on track towards building this fund and not use the money for any other things. You must make sure that you have this type of plan for your emergency fund so that you do not end up using this money for anything else. If you are married or have a partner, you both should work together to create purposes for your emergency fund.

3. Open a Savings Account 

If you have a steady job and are receiving regular deposits to your Checking account from your employer, then you should definitely open a Savings account. You should then set up an auto-transfer of a fixed amount from your Checking to your Savings account each month. For example, let’s say you receive a monthly salary of $4,500 as a direct deposit to your Checking account. You should then set up an auto-transfer of at least 10% of your income to your Savings account. In this case, you would have $450 auto transferred every month to your Savings account. And, within a year, you would have about $5,400 saved in your Savings account. Some banks even allow you to create categories with your Savings account so that you can then specify how this Saved up amount would be assigned towards your Emergency fund, Travel fund, College fund, etcetera. Similarly, if you were to set up the auto transfer to 25% of your income, then you would be saving $1,125 each month, which then adds up to $13,500 in a year. Additionally, you will also receive a small interest from your bank for saving this money. The more money you set up for auto transfer, the more savings you would have set aside for your emergency fund. If you have a spouse or a partner, you should consider opening a joint Savings account for your emergency fund, and then you both should set up auto transfers to this joint account and contribute towards building this fund.

4. Hide Your Money and Only Use It for Emergencies 

By hiding your money, we don’t mean that you literally should hide your money somewhere. But you need to keep your money stashed away so that you will not touch it unless it is an emergency. If you follow the earlier suggestion of putting aside money in a Savings account, you should then stay disciplined and not touch that money for any other purposes such as buying clothes or non-essential and luxury items. Many times, most of us end up spending our entire paycheck and have no money left by the end of the month. However, when you have this auto-transfer of funds set up, the money will be moved from your Checking account to your Savings account as soon as your paycheck is deposited. So, essentially you will now be having a smaller amount available to spend for that month and you will be forced to cut your expenses and only live within the amount you now have available in your Checking account. Not seeing this money stashed away in a Savings account and forgetting about it will help you slowly build your Savings as well as your emergency fund.

Let’s summarize what we have discussed in this MoneyTalk.

Emergencies can happen anytime to anyone, but how prepared one is to deal with such emergencies is very important. By building an emergency fund, you can save yourself from many financial headaches by avoiding getting into credit card debt. If you end up taking credit card debt, then you will pay much more due to interest charges, and these unnecessary payments can put you into a vicious cycle of bad debt.

Building an emergency fund can help you deal with situations such as job loss, medical issues or even meet unexpected expenses such as car repairs. You can build an emergency fund by following these steps:

1. Do a Financial Reality Check

2. Create a Purpose for Your Emergency Fund

3. Open a Savings Account

4. Hide Your Money and Only Use It for Emergencies

And, most importantly, for becoming a financially successful person, staying disciplined is the key. If you have set up an emergency fund, saving money towards it needs discipline. Once you set up auto transfers to your Savings account, not touching that money and keeping it stashed away needs discipline. Not using that money for anything else such as paying bills, or buying non-essential things needs discipline. You really need to channel your inner core to stay motivated and on course in building an emergency fund which will then help you immensely in dealing with unexpected situations in life that require money.