Save the Sinking Ship: Set up an Emergency Fund
As an off the boat immigrant, I came the US to pursue my masters degree. I was very disciplined about my finances while at grad school, because at the end of the day I knew it was now or never and there was no back up.
As I went into the workforce the discipline of savings dwindled and I could see the impact of that in the bank account. I had no clue about what an emergency fund was or any other investments. I feel for parents who are trying to get their grip on finances and need a basic primer on what an emergency fund is. But before that here are som
· 32 percent of Americans have some emergency savings. However, those savings are not enough to cover the expenses for more than 75 days. Around 22 percent had emergency fund savings that would last for up to 5 months.
· In case of loss of job, 55 percent of Americans do not have enough money to cover expenses for 6 months
· 42 percent of Americans do not have sufficient funds to cover the expenses of an unexpected auto repair
· 36 percent Americans with high school graduation or less do not have emergency funds saved as opposed to around 10 percent of college graduates with no such savings.
· 54 percent of American adult can’t afford to make payments for medical emergencies
· Americans aged between 31 and 50 are more likely to be ones with no emergency fund savings as compared to other age groups
· Around 38 percent of adults in the US have less than $1000 as savings.
What is an Emergency Fund?
An emergency fund is a type of contingency fund that you can fall back on during tough times, such as loss of job or some sudden, unexpected heavy expense. Emergency funds are liquid savings which can be used in such times of crises. One of the main differences between different kinds of investments and an emergency fund is liquidity.
Parents are responsible for the payment of the living expenses of not just themselves but also their children. It is also more likely that parents will have unexpected expenses crop up more than single people/non-parents. Hence, it is important for parents to create an emergency fund before they begin saving for other purposes like college education for their children, etc. Preparing for the future is one of the main tenets of financial planning and an emergency fund is one of the most vital components of a great financial plan.
Emergency funds in Detail
Replacement of a broken TV with a big new TV is not an emergency situation. A true emergency is something that will have a long-term impact on an asset of value (like your house) or on your long-term health. True emergencies can include payment of a large deductible/a large medical bill, major repairs to your car, travelling or arranging money for emergencies like death in family, large repairs to home, etc.
An emergency should be large enough to help you tide through 6 months without any job or income. An emergency fund should be placed in options with no liquid, risk/low risk options like FDIC insured bank savings or checking accounts or bank CDs, money market accounts, treasury bills, bonds, and notes. It can also be held as physical cash.
Emergency funds help get the money that is needed when you come up short. Such fund has to be a reliable source of money and hence has to be a guaranteed investment. Thus, stocks are not good source of emergency funds, while savings accounts are.
An emergency fund should be liquid with easy and ready access to the money. Thus, it should be short term liquid money. However, as we will not use the fund other than in case of an emergency, it ends up being long-term liquid funds. Short-term savings are low interest yielding, while long-term investments offer moderate to high returns. Therefore, we can divide an emergency fund into two types of savings, i.e. a short-term liquid fund and a long-term liquid fund.
The short-term fund should be kept for immediate smaller emergency expenses like replacement of key appliance, car repairs, etc. It has to be accessible and really liquid. Hence, for this a savings account with check-writing and debit card facilities is the best option. This money can also help go through the few days that may be needed before you get access to long-term emergency fund saving.
Long-term emergency fund has to be used for larger, extreme emergencies like natural disasters, loss of job, etc. It has to be accessible and easily liquid, but it has to be placed in investments which offer a higher interest rate. Roth IRA and low-risk stocks and bonds are a good option for long-term emergency fund investment.
Click here to view my article on how to save by buying used vs new cars.
How to save for an emergency fund?
Creating and saving for an emergency fund is not that hard. Provided below are a few tips on how to go about doing that:
- Break down the process. Find out the amount that you need in your emergency fund account and how much you can save each month. Then, start small and slowly grow the investments into the account each month, till you reach a satisfactory level of savings each month. This can help avoid unnecessary tension and make the process more manageable.
- Make the process of depositing money into the emergency an automatic one. Set up your emergency fund account and your paycheck in such a way, that a chosen sum is deducted from each month’s paycheck and automatically deposited into the fund. This will avoid the problem of forgetting to put money into the fund.
- Ensure that the emergency fund is separate and not a part of your savings account, else you will end up spending it.
- Find out all unwanted, wasted, and unnecessary expenses, cut down on them, and add it to the emergency fund. Saving on household wasted expenditures can help save nearly 10 percent of total expenses. A wasted expense can be keeping a light on, a computer on, etc even when not needed; routinely, excessively ordering food from restaurants, etc.
Take lunch to work instead of ordering. It can help save around $10 a day. Reduce or avoid drinking coffee at restaurants and instead make it at home. It can help save $5-6 a day.
Verify the amount of groceries purchased. If it is in excess reduce the quantity to the level that you actually need. Cut back on unhealthy foods like sodas, chips, cookies, etc.
Reduce/cut back premium cable channels, smokers can quit smoking, cut back on different subscriptions or app services or gym memberships, and negotiate with cell provider to lower phone bill. All these can help save over $100-400 a month.
Add dividend earnings to the emergency fund. It may not add big money into the fund nor is it the fastest method to add to the savings, but it can definitely help bulk up the emergency fund.
Article on Dave Ramsey’s site on Emergency Funds.
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