Could a Single Emergency Wreck Your Finances?

By Markets Fool.com


Image source: Pixabay.

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There are statistics aplenty showing how little most Americans have saved for retirement. Even more troubling, though, is new data showing how many Americans have saved little to nothing for emergencies. Retirement is years or decades away for most adults, but an emergency can strike today.

Bankrate released data earlier this summer revealing that a whopping 28% of Americans have no emergency savings at all, while close to half of us haven't saved enough to keep ourselves afloat for three months. That's a big problem.

Don't leave yourself vulnerable to disaster. Image source: Pixabay.

No one is immune to emergencies

Financial emergencies can happen to anyone. You may not expect to lose your job anytime soon, but sudden layoffs are not unheard of. Even great companies occasionally thin their ranks or make strategic shifts that involve workforce changes.

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You may be fit as a fiddle, but even triathletes can have short-term or chronic health issues that lead to sky-high medical bills and time off from work.

Then there are the countless financial calamities that, though less serious, could leave you on the hook for a huge expense. You may have to replace your roof, your HVAC unit, or your aging car. You might find out that all three of your kids need braces.

Any number of unpleasant surprises could require you to come up with a lot of money in short order. If you don't have an emergency fund, or at least an emergency plan, then you could end up wiping out a retirement account or charging thousands of dollars on a high-interest credit card. You could even end up losing your car or your home.

Indeed, according to a 2015 report from the Pew Charitable Trusts, fully 60% of American households "experienced a financial shock" over the past year, with about a third of them experiencing two. What does such a financial shock look like? The median cost of households' most expensive emergency was $2,000, or about half a month's worth of household income. More than half of households had trouble making ends meet after experiencing that shock.

Image source: Flickr user James Cridland.

What to do

The best way to protect yourself is to have an emergency fund available -- enough to cover between three and six months' worth of expenses. A few more months' worth will offer more protection, but at some point you'll just have too much money lying around, not growing whatsoever. That's because emergency fund money should not be in the stock market or any other place where it's vulnerable to volatility. It needs to be kept somewhere safe and stable, such as money market accounts or bank accounts. It won't grow much, but it will be protected from major losses and will therefore always be there when you need it.

How should you determine exactly how much to sock away? Well, focus on the monthly expenses that you have to pay in order to stay in your home and survive. In other words, sock away three to six months' worth of rent or mortgage payments, along with the costs of utilities, food, transportation, and anything else you can't do without. Include loan repayments, too, such as for credit card debts or car loans.

Start by changing your thinking a bit. Vow to have a fund always on hand from now on and to be an active saver. Make it a habit to put part of every paycheck into your emergency fund. Once that's fully funded, you can redirect those savings to a retirement account, and you'll never miss them. Strategies that can help you build up this emergency fund include cutting costs wherever you can and putting most or all of your annual tax refund into savings.

Don't leave yourself vulnerable to financial disaster. If you don't have an emergency fund, start building one now.

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Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.