It's a funny thing about emergencies. You don't know they're coming ... but you kind of do.
Illness. Injury. Damage to your home or car. Pay cuts, job loss, divorce, veterinary bills, funerals. At least one of these unfortunate events happens to most of us at some point: 60 percent of households experienced at least one "financial shock" in the past 12 months. More than half of them struggled to cover their costs afterward.
Financial security means more than paying your bills and saving for big purchases. It also means anticipating the unanticipated - and building up a cash reserve to cover emergencies.
Emergency funds help prevent one problem from turning into two problems. Yes, the transmission fell out of your car. But that doesn't mean you have to put the replacement on your credit card, racking up interest charges. Emergency funds create breathing room around the bad stuff, allowing life to continue relatively normally despite a job loss, broken bone, or dead refrigerator.
Where should you keep it?
Your emergency fund should be accessible but not too accessible: separate from your checking account and the savings accounts you've set up for other purposes. Depending on the size of your emergency account, it might be worth seeking out a savings option that offers higher dividends than a basic savings account. But you should be able to access it within a couple of days.
What should you spend it on?
True emergencies generally fall under three categories: medical surprises, auto-related surprises, and home-repair surprises. Broken leg? Yes! Totaled car? Yes! Sinkhole under garage? Absolutely!
Semi-annual sales and road trips are not emergencies. They might merit their own savings accounts, though.
How much should you save in your emergency account?
Financial experts often recommend stashing enough in your emergency fund to cover three to eight months' worth of living expenses.
That's a lot of money. So set smaller milestones at first. Aim for $500. After saving that much, shoot for a month's worth of living expenses, then two months' worth, and so on.
Where is all that money supposed to come from?
From your paychecks and from the money you're not spending on other things. First, set up automatic transfers to your emergency account every time you get paid. Start with a tiny percentage of each check. Build up to 5 percent.
Then try these strategies to free up some cash.
• Plug your spending leaks. Devote a couple of weeks to tracking what you spend at restaurants or vending machines during your work week, for example. Then start packing your lunch.
• Scrutinize your monthly bills for waste: pricier cellphone plans than you need, gym memberships you don't use, and video-streaming services you never watch. Cancel or downgrade those plans.
• Call your insurance agent or go online to search for better rates.
• Call your financial institution and ask if you qualify for a lower credit card rate. This could reduce your monthly payments.
• Cut your gas costs by setting up a carpool, taking the bus, or riding your bike to work or school.
• Find cheaper ways to treat yourself. Instead of paying for a meal at a fancy restaurant, prepare a fancy meal at home. Instead of hiring babysitters, trade care with another family: You watch all the kids one Saturday night, and your friends watch them the next Saturday night.
It might seem counterintuitive to save cash for an emergency that hasn't happened yet when you're facing real expenses now. But by creating an emergency fund, you're buying something you'll be glad to have: a measure of protection against the emergencies that surprise us ... but really shouldn't.
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