By Jamie Bosse
Have you ever heard the phrase, “If you don’t have an umbrella, it will be sure to rain”? Many Americans currently live paycheck to paycheck and have no cash reserves to pay for unexpected expenses or a proverbial “rainy day”. According to the Atlantic (2017), 47% of Americans could not even come up with $400 in the case of an emergency. This is a scary position to be in because the “unexpected” is just a part of life – the water heater stops working, little Johnny needs to go to the emergency room, the refrigerator goes out, the garage door comes off the rails, and windows or bones get broken.
An emergency fund is essential because your income is also exposed to the unexpected. Company layoffs, terminations, or “repurposing” is actually very common and can leave you in a pinch if you don’t have some extra cash stashed away. Even if you are able to get a new job quickly, it may not be at the same level or rate of compensation. It can get more complicated if your pay is based on commissions, restricted stock, or bonuses. Having reserves can also make it easier if you experience temporary breaks in income due to maternity leave, an injury, or disability. Here are three tips to start building your emergency fund:
People tend to spend whatever is in their checking account, so put it somewhere else from the start. Have a portion of your paycheck directly deposited into a separate savings account that you have earmarked for emergencies only and try not to look at it very often. Once you have this system in place for a while, you’ll be used to the amount you can spend each month. You should aim to have 3-6 months’ worth of your fixed expenses available in an emergency fund at all times. Once you reach that amount, you can redirect the direct deposit to another account to pay off debt, save for other goals, or to invest.
- Hide it from yourself:
Out of sight, out of mind. It is easier to build funds if you are not constantly tempted to use them. Don’t keep your emergency fund in the same bank that you use for daily expenditures. Better yet, utilize an online bank so that you don’t see the balance in your normal bank login. Often these banks will earn a higher interest rate than a brick and mortar bank.
- Take baby steps:
Building up a balance in any type of account takes time. Be patient with yourself and start slowly. If you currently live paycheck to paycheck (as 76% of Americans do according to CNN Money), finding “extra funds” can be difficult. Start looking for small ways to save a few dollars each week. You could skip the Starbucks run once a week and allocate that $4 to savings. Begin redirecting a small amount of funds directly from your paycheck, even if it’s just $25 a pay period and gradually increase it. Also, look for ways to capture “windfall” dollars that are in addition to your regular salary. Any time you receive a bonus, a gift of cash, or a tax refund, automatically put at least 10% of it into savings. When you get a raise at work, don’t spend that extra amount each pay period – redirect it towards building that emergency cushion.
Use these 3 tips to build your rainy day fund and remember to only tap into it in the case of a real emergency. Christmas is NOT an emergency! In the words of Dave Ramsey, “It happens on the same day each year”. Other non-emergencies include summer camp, college, weddings, and spontaneous shopping sprees. If you continually dip into these funds for non-emergencies, the funds won’t be there when you really need them. You can use these same three principles to build funds for non-emergency goals like summer camp and college. If you plan for these expenses and automate, reduce the temptation to access them, and take baby steps, you will start building a balance that you can use when you need it.
Jamie Bosse, CFP®, RFC