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Building an emergency fund is a necessity. Bad stuff happens to great people (that’s us) and that is an unfortunate reality. Being prepared reduces the likelihood of making a horrible financial decision to get through the emergency.
The goal is to have a little something stashed away to prevent having to take out high-interest loans to cover the emergency. An emergency should not result in a financial disaster.
If you don’t have an emergency fund, you are not alone. The US Federal Reserve determined that 40% of households cannot manage a $400 emergency? It’s true.
So, let’s fix it! Let’s build a financial safety net.
Four Key Points to Cover
- What is an emergency?
- How much should be in an emergency fund?
- How to fund an emergency fund?
- Where to save your money?
1. What is an emergency?
It can range from your car being totaled to losing your job.
Medical emergencies are a big problem if you do not have insurance. Even if you do have insurance, short-term disability typically does not cover the full salary. Additionally, if you are new at a job, you might not yet qualify for insurance.
2. How much should be in an emergency fund?
This really depends on your unique situation. Most literature recommends 3-6 months of your salary. Remember this is ideal. Remember everyone starts at zero, nada, nil in her emergency fund.
3-6 months is a wide range, so how to determine how much money is right for you?
Evaluate your unique situations to determine how big to build your emergency fund.
The fundamental question is how strong is your safety net?
Ask yourself some honest questions including but not limited to:
- Are you spending your entire salary today? What is the amount you are currently living on?
- Do you have an additional income stream (spouse works) and can you live off one salary if necessary?
- How quickly can you get another job if you lost your current job?
- How good is your health? Age, weight, diet, drinking, smoking are all risk factors.
- Is your car in good working order?
- If your car got totaled, could you take mass transit instead of driving or get a ride from someone else?
- Can you move in with family/friends if you don’t have an income?
The answers to these questions will help you determine if you feel comfortable with closer to 3 months salary set aside versus 6 months salary.
For example: Moving in with a relative might not be ideal, but knowing that is an option might decrease the amount of money that is needed in building your emergency fund.
3. How to build an emergency fund?
It is overwhelming to think about saving 3-6 months of salary in addition to paying off debt and daily expenses.
Maybe you will get lucky with a windfall from a great tax refund. If not, try taking a slower approach to building up your emergency fund.
If you have nothing saved, trying saving $600 in the next year and add to that foundation. $600 is saving $50/month. If you are a go-getter, start with committing to saving $1,000 in the next year.
Question: How hard is it to save $1,000?
Answer: Have $20 per week automatically deposited into your savings account.
Genius Math Time: $20/week X 52 week = $ 1,040/annually
There are many ways to cut out costs to find $20/week.
Here are 100+ ways to save money
17 Frugal Money Saving Tips which has “no cost” ideas to cut back on expenses.
50 Money Saving Tips has even more ideas.
26 No Spend Weekend Ideas is filled with free activity ideas.
29 Ways to Save on Your Electrical Bill is the start of a three part series dedicated to reducing electricity use.
If you need more inspiration, visit our “Saving Challenges” board on our Pinterest site.
We personally like any method that creates a savings habit and can be automated. Use the money saving tips to save that $20/week and then have your bank automatically put $20/week in your savings account.
The goal is to keep saving after you have built up your emergency fund.
Now if you want to put your spare change in a bucket and add that to your emergency fund. Go for it! Every penny does help.
4. Where to put your money?
Not under your mattress.
Now seriously, you need to have money available relatively quickly, but you also do not want the money to sit stagnantly.
In all likelihood, the bills from the emergency will probably be hitting the checking account 30-days after the incident, especially if a credit card was used for the initial payment.
The best low-risk options are a high-interest savings account, a very short term bank CD, or 4-week US Treasury Bills. None are offering great returns right now, but it is better than nothing.
Basic savings accounts pay well less than 1%, so shop around to find a higher-yielding savings account.
Treasury Bills can be purchased through TreasuryDirect (www.treasurydirect.gov).
Why Consider Treasury Bills
- Allows for Short Time Frame and Low Entry Dollar Amount Required. Treasury bills can be purchased in as little of $100 increments and in as short as 4-week duration. So, if there is an emergency, we can get our money back quickly and hopefully before the credit card bill is due!
Currentinterest rate is close to the inflation rate and bills are backed by the US Government. In 2020 and depending on the maturity date for the Treasury Bills, bills are close or covering the inflation rate. This investment will not make you rich, but you should not lose money either.
- Tax Advantage: No state or local taxes on earnings – important for those of us living in high tax states. There is still federal tax. This is an important consideration when comparing to other options like CDs and high interest rate savings accounts.
- No brokerage house fees. Treasury Direct is run by the US Government and there is no middleman.
- Easy to set up. There is a tutorial on the website. It takes less than 15 minutes to set up the account. This is arguably one of the US Government’s most user-friendly websites.
Recognize that rates do change, so you should re-evaluate your savings method at least annually. Do your homework. It is your money.
Unfortunately, emergencies happen to the best of us. Building an emergency fund helps protect us from taking on unwanted debt like high-interest credit card debt.
Creating and funding an emergency fund savings plan is a critical first step to financial independence. Have confidence in yourself and know you can accomplish this goal in the next 12 months.
We always appreciate people sharing our articles and hearing back from our readers. Let us know how you are doing on your financial independence journey. Ready to move forward on your financial journey? Start the WhipperSnapper Finance 9 Week Financial Challenge by signing up for our email. You got this!
Good Luck, Whippersnapper Finance