Saving for emergencies is a must for all adults. Without an adequate rainy day fund, the loss of a job, a car malfunction or another unexpected cost can potentially drain your checking account, slash your retirement fund and increase your debt.
Luckily, emergency funds are not completely off the radar for many Americans. In 2010, 35.2% cited “liquidity” as the most important reason that their family saves. This percentage has increased by 5% since 2004, so savers are becoming increasingly concerned with the onset of a financial emergency.
Even for those who recognize the importance of a rainy day fund, the decision of how much to save can be a murky issue. In dollar terms, the desired amount of precautionary savings increases with income, but generally represents the same percentage of annual income (about 11%, according to the Federal Reserve’s Survey of Consumer Finances).
Before you begin saving, it’s important to outline a plan. This plan should consist of three primary questions.
- How much to save?The most common recommendation is to save for 3 months to 1 year of basic living expenses. Of course, this will vary from household to household. Try recording all of your essential expenses for typical month, and multiply by how many months of savings you feel comfortable keeping in reserve. Then add a slight buffer to allow for a surprise hospital bill or a similar unexpected expense.
- How to reach your goal?Accumulating a significant rainy day fund will be no short-term feat for most, but every little bit counts. First, determine a reasonable goal to set aside from each paycheck. There are a number of tools to help make the process easier, such as automatic transfers to a savings account, budgeting software and more. There’s no right or wrong answer, so choose whichever is most effective for you.
- Where to keep the money?You’ll want to keep this cash easily accessible because, as is the nature of emergencies, they are unexpected.
- Some may choose a checking account for this purpose, but besides rewards checking these don’t often pay interest.
- CDs pay higher interest, so your savings could be working for you as well as act as a financial backstop. However, these accounts require locking up your funds for months at a time and early withdrawal can trigger penalty fees.
- High-yield savings accounts, found at online banks and some credit unions are a great option. You’ll have quick and easy access to the money, and the best accounts can yield even more than many CDs.
Other expert opinions
- Alan Moore – Founder and Financial Planner at Serenity Financial Consulting
What are the odds that you could lose your job, and how long would it take for you to find a new job? If you are in a high demand career and are confident you could get a new job within just a few weeks, then 3 months of living expenses is probably sufficient. If you are in a highly specialized field, and it would take a while to get a new job, and might even include you having to move to a new city, you want to be sure you have at least 6 months of living expenses in your emergency fund.
What level of disability insurance do you have? Many employers provide disability insurance, however it may only pay after you have been disabled for 3 or 6 months. Check your policy, and then be sure you have enough saved to cover this period of time.
Do you have another income source? If you have a spouse that earns enough to cover your families living expenses, you might have less in your emergency fund. If your spouse has chosen to stay at home, how long would it take them to find a job to help support the family if you are no longer able to work? Be realistic about how long it will take for you to begin earning income.
- Kevin Gallegos – VP of Phoenix operations for Freedom Financial Network
Realize that six months of living expenses is not the same as salary, or even the amount you normally live on. It is the amount to cover essentials only. In an emergency, we don’t fund vacations, fancy new clothes, dining out or other luxuries (big or small). The idea of socking away half a year’s expenses can induce a mild panic. But before you write off this bit of financial planning wisdom as impossible, look closely at what it means — and realize that, with time and patience, anyone can be prepared for the unexpected, whether a job loss, illness or surprise addition to the family.
You don’t need to be a certified expert to plan wisely
Here’s what two consumers had to say about their personal situation:
- Sarah Tetreault – wife, mother and founder of lifestyle blog Go Gingham
…folks shouldn’t be so concerned about a “number” as much as access. If you suddenly find yourself with no income, you have to be able to get to your cash quickly and should have 1 or 2 options in place, before an emergency need strikes. These could be home equity loan/line of credit or a savings account that can be accessed without having to “sell” something – like a CD or stocks. If folks have neither of those as options, they should focus on “redirecting their resources” (which sounds infinitely better than “cutting
back and saving”) toward themselves. Working toward a financial goal – whatever that may be – is always worth it.
- Tam Denholm – freelance web developer
As my income is very sporadic a rainy day fund is important to me. I keep 2 funds stocked, 1 is my business fund that is stocked with at least 6 months worth of wages incase I hit a dry patch and don’t get any work. The other fund is my emergency fund, which is for things that are unforeseen and aren’t covered in day to day living expenses.
If you have a regular income perhaps Fund 2 is more what you would be working towards. I would personally recommend it be enough to cover things like your car breaking down, emergencies in the home or medical expenses.
Rainy day image via shutterstock