March 2014
Barbara O’Neill, Ph.D., CFP®
Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension
Media reports and advertisements by financial firms provide lots of advice about how to become financially secure, but the simplest and most basic strategy is to save a portion of your income on a regular basis. A financial goal that every individual or family should have is to establish some type of emergency fund. This is savings set aside specifically to meet emergencies (e.g. medical expenses due to an accident), unanticipated bills (e.g., auto repairs) or to cover monthly living expenses if your paycheck stops (e.g., disability and unemployment).
Emergency funds have been compared to a “shock absorber” for inevitable “bumps” on the road of life. The money placed in them should be liquid. In other words, emergency savings should be put into accounts that can easily be converted to cash without loss such as checking or savings accounts, money market deposit accounts, or money market mutual funds. Liquidity allows quick access to funds, which is vital in emergency situations.
You may think you can’t afford to have an emergency fund, but you can’t afford not to have one! Stuff happens and, most of the time, it costs money! By setting up an emergency cash fund, you help protect yourself from the financial cost of unknowns. Without an emergency fund, people often use credit cards or payday loans or borrow money from family members in an emergency because they don’t have a savings account to fall back on when unexpected things happen. This just digs them further in debt when interest is charged on unpaid balances. Worse yet are situations when family relationships are strained over unpaid debts.
Make establishing an emergency fund a priority. Fund it with approximately three to six months of living expenses or whatever gives you peace of mind. If you need $2,000 a month to cover living costs, you need $6,000 to $12,000 in reserve. Whenever you withdraw money from the emergency fund, pay yourself back based on a predetermined schedule as you would any other bill. Discipline yourself to use emergency fund money only for real emergencies (e.g., car repairs, broken appliances, sickness, etc.).
Keep your emergency fund in a liquid savings product such as a money market mutual fund or short-term certificate of deposit (CD). Don’t place it in investments such as stocks and bonds where it will be subject to short-term market volatility and losses if you had to withdraw funds to cover an emergency expense. Shop around to earn the highest annual percentage yield (APY) on your emergency savings. The highest interest rates on savings can often be found on accounts at online banks and credit unions.
Any small step toward accumulating a minimum of three months expenses is better than doing nothing. To get started, save $5 or $10 per paycheck or whatever you can afford. Place money for emergency savings automatically in a credit union account savings (share) account through direct deposit from your paycheck or transfer it yourself from checking to savings.
Another way to start an emergency fund is to save $1 per day, plus pocket change, in a can or jar. At the end of each month, you should have saved about $50 or $600 after one year. However you decide to fund an emergency savings account, develop a schedule and stick with it. Make emergency savings a priority and “pay yourself first.”
Benefits of an emergency fund go beyond dollars and cents. Having an adequate emergency fund also provides peace of mind that you are not living on the financial edge.” This reduces stress which is often associated with physical ailments such insomnia and anxiety. Emergency funds may also reduce marital arguments about finances.
The most important thing is to get started now. If you are already saving for emergencies and need to save more, try increasing the amount that you save. The results, over time, will be amazing. For additional information about the benefits of saving, visit the America Saves website.