If you face major unexpected financial expenses next week – for example, due to a job loss, a medical procedure, or a home repair – do you have the funds conveniently available to handle the situation without taking out a loan or adding debt to your credit cards?
Probably not, especially if you are among the 57 percent of Americans who have less than $1,000 in their savings account, according to a survey done last year by GOBankingRates. That means most of us are walking a financial tightrope every day, whether we fully realize it or not.
During our current strong economy, it’s easy to ignore the importance of building and maintaining an emergency fund. However, economic good times never last and life always throws us financial curveballs.
By having a stash of cash set aside, your monetary surprises can be an inconvenience rather than a crisis. You can avoid panic and have the peace of mind to sleep soundly at night.
Let’s look briefly at the details of building your emergency fund. This discussion focuses on household budgets, but you can apply many of the same principles to prepare your small business for financial emergencies.
How big should your emergency fund be?
Typically, three to six months of expenses is recommended -- but the exact amount depends on factors such as the stability of your income and the amount of your spending.
For example, a two-income family or people who have been in their jobs for many years can consider a smaller emergency fund than a family that depends on income from one job, from straight commission, or from self-employment.
Also, build a larger emergency fund if a family member has serious medical problems, if you live in an older home, or if you drive an older car. All of these situations expose you to unexpected financial hits that can be big.
What’s an emergency – and where should I keep my emergency fund?
It’s essential to have quick, easy access to your emergency funds – but you want to avoid the temptation of dipping into this reserve for non-emergencies. So be sure to keep your emergency stash separate from your regular funds and accounts.
A good solution is a high-yield savings account – it pays interest and it is federally-insured up to $250,000. Also, you can arrange convenient direct deposits with your employer for a portion of your paycheck and you can easily withdraw or transfer money.
What kind of situations are “non-emergencies” and should not be paid out of your emergency funds? Events such as weddings, holidays, and birthdays. Expenses that were expected but were not budgeted, such as car insurance or a vacation trip. Purchases that you justify because they are a “good deal” or because they are part of a “retail therapy” shopping spree.
How can you build an emergency fund?
- Set a weekly or monthly savings goal – Set aside an amount you can afford, whether it’s $10, $100, or more. Saving will soon become a habit and you’ll be surprised how quickly the balance grows in your savings account.
- Spend less – What expenses can you eliminate comfortably with little or no impact on your lifestyle? Examples include cooking more meals at home; avoiding expensive take-out coffee; carpooling to work; or reducing your premium TV package.
- Save the change – Every night, empty your purse or pockets and put all coins plus any $1 bills into a special jar at home. When the jar fills up, deposit the money into your savings account.
- Sell things – Go through your closet and garage to find things that you can part with. Offer items on eBay or through a lawn sale, perhaps in partnership with a neighbor or work colleague.
- Use less plastic – The United States has the world’s most charge-happy lifestyle. It’s relatively easy to get a credit card in our country and it’s even easier for us to buy almost anything by swiping our plastic.
So it’s not surprising that the average American household carries about $10,000 in credit card debt from month to month. This costs you a lot in interest and perhaps even more in late fees if you miss any payments.
When you charge less, you save money, for example, the average person in France charges only about $300 per year to a credit card and saves more than 10 percent of income. In contrast, the average American charges about $4,300 annually and saves only about 4 percent of earnings.
- Pay off debt -- The only long-term debt that most people should have is their mortgage and their car payment. Too many people buy too many things on the installment plan, then the monthly payments gobble up their income and reduce their options for saving as well as for making any other purchases.
The first debts you should reduce or eliminate are the ones with the highest interest rates. And then avoid adding new debt – buy things only when you can afford to pay them off within the next 30 days.
- Investigate insurance for things you cannot cover – Examples include supplemental medical insurance for unexpected health-related expenses; term life insurance for basic funeral expenses and payments to your primary dependents; and adequate home insurance for major weather events and adequate comprehensive auto insurance for accidents.
- Earn extra income – If your schedule and energy level permit, work overtime or take a second job, perhaps just short-term until you pay down debt and get your emergency fund to certain levels. And when you spend more time working, you have less time to spend money!
Bad economic things happen to all of us from time to time – although hopefully, not too severely and not too often. And most families don’t have rich relatives who can come to the rescue.
So it’s up to each of us to minimize the risks of financial catastrophe to ourselves and to those who depend on us. Start your emergency fund today and an economic disruption will not become an economic disaster.
Navin Shah is Chairman of Royal Hotel Investments, which owns and operates two hotels in Covington and one in Conyers. He is also Vice Chairman of Embassy National Bank, a community bank in Lawrenceville that he helped establish in 2007 and has become one of the leading SBA “Preferred Lenders” in the southeast. He can be reached by e-mail at email@example.com