Achieving financial peace of mind isn't easy. Holding on to it can be even harder. A major step toward achieving both of those goals is to build an emergency fund. Indeed, it's reassuring to have money available if you lose your job, experience health problems, or face emergency home repairs or other unexpected expenses. Here are questions to consider when building your emergency fund.
You may have heard that you need cash savings of three to six months of living costs. But this rule isn't as straightforward as it may sound.
Some experts say you need to save enough to cover three to six months of expenses. Others believe you should save three to six months of take-home pay. Depending on your family's financial and other circumstances, you may need to save an amount at the lower end or aim for the six-month target.
Emergency fund savings targets often are expressed in terms of take-home pay, but most people are better off focusing on expenses, particularly nondiscretionary expenses. During a temporary emergency, you can eliminate spending such as vacations, entertainment, dining out and nonessential shopping. Your emergency fund must cover mortgage and property taxes or rent, utility, phone and Internet bills, car payments, food, health care, insurance, and credit card or other debt payments.
Determine the target size of your emergency fund by totaling nondiscretionary expenses over the time period you anticipate it would take to find a new job or cover another emergency. Be sure to subtract other income sources, such as a spouse's salary or rental property income.
Keep in mind that reasonably foreseeable expenses aren't emergencies and should be saved for separately. For example, you may expect you'll need to replace your roof in two years. Or you may be planning an elective medical procedure or a family celebration in the near future. Don't dip into emergency funds for these planned events.
At the same time, try not to save too much. If you save substantially more than you'll reasonably need in a low-interest savings account, you may actually lose money to inflation over time. Plus, you might miss out on opportunities to invest those funds in tax-advantaged retirement accounts or in other assets.
If you don't have an emergency fund, you're not alone. According to the Consumer Financial Protection Bureau, 24% of Americans have no emergency savings, 39% have less than a month's worth of expenses saved and 37% have more than a month's worth. If you land in one of the groups that would be forced to turn to credit cards, subprime loans or other undesirable methods to finance an emergency, start building your cash cushion immediately.
You might arrange for a portion of every paycheck to be deposited automatically in a savings account. Also consider reducing certain expenses, such as entertainment subscriptions and restaurant meals. Or adjust your tax withholdings, so you receive more currently instead of a tax refund when you file your annual return.
Get in touch today and find out how we can help you meet your objectives.
