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Most people face some sort of financial emergency during their lifetime. This could range from a job loss or health scare to home and car repairs.
And it's not always easy to prepare for these unexpected expenses. According to a 2011 survey by the National Foundation for Credit Counseling, 64% of Americans don't have enough cash on hand to handle a $1,000 emergency.
Having an emergency fund is important. Most financial experts recommend setting aside enough money to cover your expenses for at least three to six months.
Not sure how to begin? If kick-starting an emergency fund with a tax refund, work bonus, or cash gift isn't an option, you'll need to come up with a savings plan.
1. Determine How Much Money You Need
Use our calculator to figure out how much you should set aside for emergencies. Be both accurate and realistic while planning. And keep in mind that how much you spend during good times can usually be pared down when money is tighter.
Luxuries like cable television, gourmet coffee, and dining out are items that can be reduced or even eliminated from your budget during challenging times. The easiest way to determine this is by taking a hard look at your monthly expenses, such as:
- Housing, including mortgage or rent, and/or association fees
- Utilities, including gas, electricity, and water
- Telephone, cable, and Internet
- Food, including groceries, coffee, and dining out
- Transportation, including car or lease payments and fuel, or public transportation fees
- Health insurance premiums and prescriptions
- Other insurance premiums
- Health club memberships
- Retirement and other savings contributions
- Debt repayment
2. Set Up a Separate Liquid Account
Find a place where your emergency savings will be accessible — but not too accessible. Accumulating and maintaining your fund can be difficult, especially if you have easy access to it. That's why your checking or savings account probably isn't the best place to keep it stashed.
Save it in an account that's liquid — one that is easily convertible to cash, such as a separate savings or money market account.
Since even the high-yield versions of these types of accounts have lower rates compared to other savings vehicles, they may seem like an unwise place to store your emergency fund. But remember, your goal isn't to make money. It's to have a place where you can quickly withdraw money when you need it, without high-penalty fees.
Once your emergency fund contains more than a few months of expenses, you can consider an alternative, such as a certificate of deposit with a high annual percentage yield. Just make sure that you choose a short-term CD, and leave enough money in a liquid account so you don't defeat your efforts.
3. Set Up Automatic Deposits
If you wait until the end of the month to contribute to your emergency fund, there may be nothing left over. Setting up an automated monthly transfer into your emergency account is a great way to make sure you stay on track with your plan.
And once you become committed to doing this, it will help you better budget your money. You'll begin to realize what things are necessities.
4. Make Your Emergency Fund a Savings Priority
As in other types of saving, the key to building your emergency fund is to pay yourself first. But given the importance of an emergency fund, you may want to make it the top item on your savings agenda — even forgoing or reducing other kinds of saving until your fund is built up.
Although it may seem daunting to save enough to cover expenses for at least three months, it's important to start anywhere — even if it's somewhere small. You may want to set an initial goal that's achievable in just a few months, like $1,000.
Or begin with a minor amount that you increase incrementally. Your strategy could be to save only $20 a week, then raise the amount when you reach a point where you don't notice the missing income.
Most importantly, don't touch your emergency fund unless a financial emergency presents itself. When that time comes, you'll be thankful it's there.
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