Published January 31, 2012
Unexpected problems can always creep up in life, but an emergency fund can keep a bad situation from turning catastrophic. Here’s some tips on setting up an emergency fund.
How much money to save
The first goal is to decide how much money you want to save in this emergency fund. Expert advice varies significantly; but this decision is perhaps the most important of the whole process. Some financial advisers suggest saving up enough money to cover three to six months of living expenses. This might range from $6000 to $25,000. However, when dealing with emergency funds, it is important to think ahead and plan for the worst. Therefore, other experts recommend saving up a minimum of six to 10 months of living expenses. After reaching this benchmark, you can continue contributing to your emergency fund as you see fit.
Not all emergency funds are equal
The reason it is so difficult to get a standard answer from financial experts concerning the amount of money one should save is simple: not all salaries or expenses are the same. With such tremendous fluctuations in both income and lifestyle, not everyone’s emergency fund should contain the same amount of money. Consider a middle-aged parent of five with two cars and a mortgage. Now consider a single person in his or her early 20s. Clearly, the emergency fund will be far smaller for the latter.
To be financially solvent, you should keep track of your living expenses for at least one week. Although, the longer you track these expenses, the clearer your understanding of your financial situation will become. You should create an excel sheet where you log every dollar you spend: rent, gas for the car, parking, train ticket, morning coffee, lunch, dinner, drinks, DVDs, groceries, clothes, medicine and so on. Create separate columns for necessities and luxuries. For the luxuries, see if there are ways to get these items more cost efficiently. For instance, maybe you can invest in a coffeepot for your home or put off your morning cup until you arrive at work. Then again, you may truly value that cup of coffee, spending time at your local café and chatting with the barista. You may also want to contribute to their enterprise because you appreciate that business’ service to your community. If so, look for other places to trim your budget. When you figure out which items from your list can be spared, place the money that you would have spent on those luxuries into the emergency fund.
Where to keep the fund
You will need to decide for yourself whether a brick and mortar bank, a credit union, or an online bank is the right place for your emergency fund. But one thing is certain: you want to store your emergency fund in a high-yield savings account. Your emergency fund shouldn’t just sit there collecting dust while inflation renders your money less valuable by the minute. The money should increase. Then, even if an emergency doesn’t happen, you will have increased your overall savings and your financial well-being.