Let's say that you woke up tomorrow and your car had two flat tires. Or you went to the emergency room and got stuck with a $1,000 bill. Would you be able to cover these expenses without using a credit card or borrowing the money?
Only 39% of Americans would be able to cover a $1,000 unexpected expense, according to a new Bankrate.com report. Let's take a look at the alarming data, and go over how much you should have in emergency savings and what you can do if you feel unprepared for the unexpected.
Most Americans are not well-prepared for financial emergencies
As I mentioned, fewer than 4 in 10 Americans would be able to handle an unexpected $1,000 expense with their savings. 36% said they would have to borrow money in some way (including using a credit card) to cover the expense, and others said they would cut back in other spending areas to finance such an expense.
Why an emergency fund is so important
Too many Americans tend to think of emergency expenses as "rare" situations, but that's simply not the case. Unexpected expenses happen more frequently than you may think.
According to Bankrate's data, 34% of American households have had a major unexpected expense in the past year, and the tab was often more than $1,000. Of those households who reported an unexpected expense, half said that theirs cost $2,500 or more, and 30% reported spending over $5,000.
Charging an expense like this on a credit card, which one-fifth of Americans say they would do, or taking out a personal loan can end up costing thousands of dollars in interest and trap you in a cycle of debt repayment that makes it even tougher to handle emergency expenses in the future.
How much you should have
Ideally, you should have about six months' worth of your living expenses saved in a readily accessible place, like a savings account, that can be used to pay emergency expenses.
However, this can be a lot of money, and few Americans actually have this much saved. While I absolutely suggest aiming for a target like this over the long run, it can be quite a daunting task if you're starting from scratch. You don't need to get there right away. It took my wife and me years to build up an adequate emergency fund.
From a practical perspective, it's important to make sure that an unexpected expense like a car repair doesn't derail your retirement savings, impair your ability to pay your other expenses, or otherwise adversely impact your financial well-being.
If you're short on rainy-day cash, make a plan to catch up
So set a realistic goal that you could achieve in a year or so -- say $1,000. Once you've achieved this, you'll be able to tackle lots of potential expenses, and you'll be in better shape than most Americans. Then, you can focus on another goal, like $2,500. Keep doing this and you'll have a big emergency fund in no time.
My suggestion is to take your one-year goal and divide it by the number of times you get paid each year. Here's a chart if you aren't sure:
For example, if you get semimonthly paychecks and want to build up a $1,000 emergency fund within a year, you'll need to save $41.67 per paycheck in order to reach your goal.
My other suggestion: Make it automatic. When it comes to saving money, we're our own worst enemies. By scheduling an automatic transfer into a separate savings account for every payday, you can begin building up your emergency savings with no effort. You'll be surprised at how quickly the money adds up and welcome the peace of mind that comes with knowing you're prepared for the unexpected.
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