You can probably guess that an emergency fund is for financial emergencies just by the name. Everyone can agree that most financial challenges tend to pop up when they’re least expected. They can range from unexpected car repairs or medical expenses to a sudden job loss or a decrease in work hours. That’s why having a significant financial buffer is so important and can help out tremendously in these types of situations.
Without a substantial emergency fund, many people turn to other more costly alternatives in handling these financial setbacks. So, while it may not be obvious at first glance, an emergency fund actually serves two important financial purposes – 1) providing funds for the financial emergency and 2) preventing you from spending even more to overcome that financial setback.
While the uses for an emergency fund may be obvious, the costs of not having one are often overlooked.
The Hidden Costs of No Emergency Fund
An emergency fund allows you to quickly cover unforeseen expenses without significantly affecting your day-to-day finances. Now, consider the alternative: What would happen to your finances if you did not have an emergency fund?
Without an emergency fund, you would need to start looking for alternative means of acquiring the necessary money (to pay for the medical expense, car repair, etc.), such as:
- Relying on high-interest credit cards. While using a credit card may seem like a quick fix to cover the upfront cost, you may end up in an even worse financial situation if you cannot repay the balance quickly. If you do opt to use a credit card, make sure to use a low-rate card and create a plan to pay off the balance as soon as possible.
- Using costly payday loans. Payday loans may seem inexpensive because they typically charge a fee versus an interest rate. But when you look at the big picture, especially if you cannot repay the balance immediately, these loans are often some of the highest-priced instruments in the financial services industry.
- Pulling from investments. If you have money invested, you may be able to liquidate a portion of your portfolio. However, depending on the type of investment, you may not be able to obtain the funds quickly. Also, you may be required to pay a penalty for withdrawing the funds early, along with taxes on your investments.
All of these options can derail your monthly budget, hinder your financial goals, and ultimately cause even more stress and anxiety. It’s always better to be prepared for a financial setback rather than try to deal with it once it’s occurred.
Creating Your Emergency Fund
If you don’t already have an emergency fund, it’s relatively easy to get started. Ultimately, your goal should be to put aside between three to six months of living expenses in this account. While that may seem like an impossible task to many, you don’t have to accomplish this task overnight. Instead, work on building your fund consistently over time.
Here are a few tips to get your emergency fund up and running:
- Open a Separate Account
Start by opening a separate savings account exclusively for your emergency fund. You want to keep this money separate from your day-to-day funds to avoid accidentally spending it. You may even request not to have an ATM card for this savings account to limit any temptations to splurge on non-emergency expenses.
- Start Small
Building a significant savings balance isn’t going to happen overnight. Instead, work on depositing small amounts into this account regularly. As you become more comfortable with the process of saving, you can increase your contributions to grow your balance even quicker.
- Automate the Process
The best way to keep your emergency fund balance growing is to put your savings on autopilot. Payroll deduction and automatic transfers are perfect tools to make this happen. With payroll deduction, a portion of each of your paychecks will automatically transfer to your savings account on payday. Similarly, automatic transfers operate the same way, but instead of being tied to your paycheck, the transfer occurs on a date you choose – such as the 1st of each month.
Once you reach your emergency fund savings goal, move on to other investment opportunities – such as building your retirement accounts. In the end, you’ll be much happier knowing you’re prepared for any financial curveballs that life throws at you.
We’re Here to Help!
While you may not be able to determine when emergencies will arise, being prepared is your first step. As your financial partner, we offer many services to help make saving easier.
If you would like to create an emergency fund or set up payroll deduction or automatic transfers for your account, we’re here to help. Please give us a call to get started today.