Budgets and financial planning may seem easy when expenses are expected. But what happens when an illness forces a person to be out of work for a month or when a leaky roof necessitates costly replacement? Loss of income or large expenses may not be managed as easily as routine utility bills or grocery costs. Large orsmall,unplannedexpenses seemingly crop up at the worst times. Building a secure emergencyfundcanhelp people weather the storm of unexpected expenses.
What is an emergency fund?
The financial resource and investmentserviceVanguard says an emergency fund is an amount of money set aside in a dedicated savings account for the purposes of providing a financial safety net. The money can be used to navigate unexpected medical bills, a job loss, car replacement, or other sizable expenditures. Without savings, even a minor financial shock can contribute to a situation that is challenging to overcome. If such expenses generate debt, that can have a lasting impact.
How much do I need? The amount needed in an emergency fund varies depending on each person’s situation. However, Morgan Stanley suggests having enough to cover three to six months’ worth of expenses. Theamountmayvaryifthere are multiple income streams and should be affected by the number of dependents a person has.
How do I set up an emergency fund?
Theeasiestwaytosetupan emergency fund is to consider using a basic savings account or money market account and linking it to a checking account. The money should stay safe and liquid until it is needed. It should not be invested in stocks or even bonds, where balances can be affected by market risks. If the emergency fund is linked to an existing account, one can set up automatic deductions from the checking account to go toward deposits into the savings account. This is known as automatic recurring transfers. Setting a goal regarding how much to save each month can make it easier to put money away.
Review expenses to identify ways to save Individuals can devote more savings toward an emergency fund if they routinely assess spending and then figure out where they can pare down. Nonessentials, such as dining out, streaming video services, travel, and other luxuries, can be reworked to potentially free up more money for an emergency account.
Address debt and prioritize building an emergency fund Some people must balance building an emergency fund with paying off existing debts. Many financial experts suggest setting up a small emergency fund first, and then beginning to pay off high-interest debt with the ultimate goal of setting aside more money for the emergency fund. Any money savedoninterestfrompaying off high-interest debt can be funneled back into savings down the road.
An emergency fund can protect individuals from taking on debt and facilitate a quick rebound from an unexpected financial blow.