If your savings don’t carry you through a storm, you’re putting yourself at severe financial risk
Indeed, the latest federal government downfall has demonstrated the need to follow a basic rule of financial management: having a reserve fund to handle emergency expenses, like significant property repairs, medical expenses or loss of a job.
However, many Americans need more basic savings to deal with emergencies. According to a recent Federal Reserve study PDF, four out of 10 people claim they could not meet an unexpected $400 expense without borrowing or selling something.
Lacking the cash to pay unanticipated bills, families frequently resort to expensive solutions, like using credit cards. Federal employees have been forced to rely on meal centers or draw on their retirement savings accounts, leading to tax penalties.
Many families indeed struggle to deposit this money into an emergency fund. Plus, it is sometimes tricky to calculate the amount to save. Here, we offer a method for figuring out the value of a reasonable reserve fund for your situation and ways to accumulate those savings gradually over time.
Ways of Setting a Savings Goal
To establish this goal, several financial experts advocate that people have a rainy day fund with enough money to pay for basic expenses for 3-6 months. According to Craig Jaffe, a licensed financial advisor and executive director of United Capital based in Boca Raton, Florida, this fund will commonly cover most ongoing bills, like lodging, food purchases, utilities and tuition repayment for student loans.
But according to Joe Pitzl, a licensed financial advisor in Arden Hills, Minnesota, your rainy day fund should suit your financial situation. That’s because employees with fluctuating incomes, such as commission-based work, and those in precarious industries or with higher projected costs may feel the need for more than six-month savings.
“Suppose your auto is constantly stalled, or your home is old and needs frequent repairs. Then, you must add these expenses into that emergency fund,” advises Brandy Wright, an Atlanta-based licensed financial advisor with Modera Wealth Management. (An online savings calculator for emergencies will help you develop an estimate of your emergency expenses.)
For retirees, the need for a substantial emergency fund is paramount. If you depend primarily on your income from Social Security, plan for a 3–6-month cash flow. For those who tap retirement portfolios as a source of income, a full year’s supply of cash is best in either 401(k) or IRA portfolios. By doing so, you’ll eliminate the possibility of selling investments if the market takes a turn for the worse or in the event of a medical emergency, Wright says.
Tips for Getting There
Once you’ve set your savings goal, you’ll probably be puzzled by this amount. Rest assured, though. There’s no requirement that you raise this amount in the short term. What is essential, however, is that you get started on the road to that target. These few steps will help.
- Establish a timeline. It will take some time to gather a substantial fund for a rainy day, perhaps 1 or 2 years. But by accumulating small amounts up front, you’ll significantly reduce your financial jeopardy.
“Even with as little as $500 in savings for emergencies, you’ll avoid incurring a debt on a credit card for a minor auto repair,” states Wright.
Thanks to this online calculator, you’ll know roughly the amount of money you must put aside on a regular basis to achieve your financial goal and at what rate that money will build up.
Let’s assume that your basic living expenses are $2,000 every month. Putting aside up to $100 per week for a rainy day, you’ll accumulate around $6,000 over a year and a half, assuming that this money will earn you 2%.
If it takes much longer to accumulate a sufficient reserve fund, try to find opportunities to accelerate the process, like saving earnings or salary increases or reducing discretionary spending.
- Choose an appropriate place to keep your money. Opt for savings or money market accounts as a place for your emergency fund. “Then, you earn interest, and your funds are accessible without penalty,” explains Pitzl.
To maximize safety, deposit your funds in a bank or cooperative credit union, where the federal government will insure them. Avoid taking risks with your cash.
However, try to get your account’s best return on investment. Most of the highest savings rates are through online banks or credit unions, which recently offered rates of 2% and higher, reported Bankrate.com.
Also, it’s essential to maintain your reserve account apart from your checking one. “Otherwise, it would be too tempting for you to use that money for unnecessary expenses, such as going on vacation,” Wright points out.
- Balance it out with other pressing needs. While putting aside savings for emergencies is a priority, you probably have other priority financial obligations, like a debt from a high-interest card. In fact, based on a recent survey conducted by NerdWallet, it is estimated that American households with outstanding debt on credit cards average $6,929 in recurring balances.
Given the average interest rate on credit cards of 17.7%, allowing this debt to grow could undo the benefits of your rainy-day savings. Therefore, it’s best to maintain a balance, with a portion of your savings going toward paying down your more expensive debt and the rest to your reserve fund.
The detailed breakdown of the amounts allocated to these needs will vary according to the percentage of interest on your debt, your other obligations and your financial resources. (To learn more about repaying your outstanding debt from credit cards, check out our post here).
“Consistency and dedication are key,” declares Marguerita Cheng, a licensed financial advisor and CEO for Blue Ocean Global Wealth based in Gaithersburg, Maryland.
- Set up an automatic savings system. To ensure an emergency fund is in place, initiate automatic deposit to transfer a set sum from your regular paycheck directly into an emergency account. Then, you won’t have to worry about transferring it yourself once a month.
Alternatively, if your workplace is unwilling to implement separate deposits, set up an automated bank transfer from your regular checking account to your emergency account.
Setting an automatic transfer and forgetting about it reduces the urge to waste those funds on overspending. Plus, not having that money in your current account means you will not regret it as much. And in an emergency, the availability of those savings will be a big help.