Your paycheck covers all your bills and even allows for an occasional night on the town, but down deep you know that a leaky roof or unexpected car repair will have you scrambling to pay up — and probably will add to your credit card debt.
What you need is an emergency fund — a rainy-day reserve that will allow you to cover unforeseen expenses while keeping your debt burden low and your finances in good order.
It’s a good idea to have about three to six months of living expenses in an emergency fund to cover potential financial setbacks including job loss. That could take a long time to save, but don’t let it keep you from even starting. The important thing is to start building your emergency fund little by little, by setting aside as much as you can.
We asked financial advisor Kathryn Hauer to offer some tips on creating an emergency fund and to explain how the lack of one can harm your finances.
What are some tips for creating an emergency fund?
Few of us have extra cash at the end of the month, but any amount you can contribute to your emergency fund is good. “Found” money, like a rebate or cash you get for returning a pair of shoes or a birthday gift, can add to that fund relatively painlessly.
Here’s another tip: If you’re paid every two weeks, there are two months each year where you get three paychecks instead of two (52 weeks a year, 26 paychecks, 12 months). Consider sending all or part of that extra money to your emergency fund, if your monthly bills are paid.
How can the lack of an emergency fund harm people’s personal finances?
Having an emergency fund gives you the power to make better decisions when problems strike. For example, if your transmission goes out, you have the money to get it fixed without borrowing. With no emergency fund, you’re likely to turn to credit cards, piling on high-interest debt. If your credit cards are maxed out, you might even be forced to turn to a crippling payday loan at 300% interest.
In what kind of account should savers keep an emergency fund?
You want to have quick and easy access to the money in your emergency fund, so you’ll want to keep that money in a savings account or money market account that you can get to easily when that emergency occurs. I recommend a local bank or credit union so you can drive over and personally pull cash out. This provides easy accessibility to your cash, while keeping it separate from your checking account, where your savings could be too tempting to access for non-emergencies via an ATM.
Online savings accounts are good options, too, and generally pay higher interest, but keep in mind that ATM access and withdrawal policies can differ. It may take a day or more to get your money in some cases.