According to a survey, nearly 60% of Americans have less than $1000 in savings, and many have nothing at all! This could be down to a number of causes, from low wages and high rates of debt to overspending.
Conventional wisdom is that the most important component of a sound financial plan is an emergency fund. Having a reserve of savings in case of a financial emergency is even more important than investing!
What is an emergency fund?
Emergencies can happen at any time. Whether it is a sudden accident, illness, job loss, car or home repair or anything else that leads to a substantial bill to pay, financial emergencies can devastate your financial stability. Unfortunately, some emergencies cannot be avoided, but they can be planned for. An emergency fund is the best kind of preparation that you can make.
However, it can be difficult to know what amount to save for your emergency fund, and the best amount can vary depending on your circumstances such as work situation and financial obligations.
How much should you save for your emergency fund?
Generally speaking, it is often recommended that you save somewhere between three to six months of expenses. However, the amount recommended by financial experts varies – from only a few hundred dollars to a year’s income! When deciding how much to save for emergencies, keep in mind your own personal circumstances, such as mortgage/rent, number of dependents, vehicles, and any other outgoings. Also, consider your job stability and career plans.
One strategy to working out how much to save is to think of it as insurance – savings are essentially an insurance policy in case of emergency! When choosing insurance, you aim to strike a balance between covering yourself and having your money sit around instead of being put to use. Like insurance, the more secure your financial position, the less of it you might need. Depending on your life situation, three months’ worth of expenses may be more than enough.
Where should you keep the fund?
An interest-earning bank account is usually the best place to keep your emergency fund as your money will accumulate value over time. Other options, such as investment in stocks, have the potential to accumulate value faster, however, they also have the potential to do the opposite! When saving for emergencies, stability is usually the most important thing. Your account should also be easily accessible – it is for an emergency after all!
Beware Overfunding
It may seem obvious that the more money kept in your emergency fund, the better. However, overfunding is also a danger and can mean that you achieve your financial goals far more slowly. Like all things in life, saving is about balance.
For many of us, especially those on lower wages, even three months’ worth of expenses can seem a dauntingly large amount to save. If this is the case, do not give up, and remember that every little helps and that even a tiny amount saved is better than nothing!