When it comes to saving money, many turn their nose because they do not believe in saving for a "rainy day." And when payday arrives, it can be disappointing and may seem unnecessary to save some of the money for an emergency fund. It is not until that "rainy day" comes that you suddenly have to pay for a traffic ticket or car maintenance. Though it may seem unnecessary to set aside money for a hypothetical situation, the reality is that emergencies can happen at any time. Having funds set aside can prevent you from borrowing money and potentially ending up in debt.
What's the Benefit of an Emergency Fund?
All in all, an emergency fund is used to keep you from going into debt. Life is uncertain, and unexpected events like losing your job, unforeseen medical bills, or home and automotive repairs are bound to happen anytime. Being prepared can save you from immense financial stress.
You can start building an emergency fund with money lying around, from spare couch change to the cash in your piggy bank. However, before you begin saving for your future and to ensure that you do not over-save to the point that you cannot spend on your necessities, there are a couple of essential steps to take before you open an account to save for your future:
Track your expenses and make a budget. Find out how much you usually spend each month, track everything you bought (from groceries to the mortgage), and then assess what is necessary and unnecessary that you would typically purchase. When creating your budget, work around it and make a budget based on your expenses that is also respective to your income. Then, create a strict monthly budget and use any extra money that is used for overspending/on unnecessary items for your emergency fund.
How do I Pick the Right Account for Saving for Emergencies?
Protecting your emergency fund by avoiding investments in stocks or bonds that may result in losses is important. The best option is to keep your funds untouched, and you can do this by placing them in a money market, high-yield, or simple savings account. While a money market account has a high minimum balance requirement and limits monthly withdrawals, it offers higher interest rates than a regular savings account.
A high-yield savings account is also a good option as it allows you to earn interest on your deposit, and your funds are easily accessible. However, the interest rates are variable, and it's not suitable for long-term savings. Lastly, a savings account is liquid and pays interest, but there are restrictions on how many withdrawals you can make each month. Typically, the maximum monthly withdrawals for a savings account is six.
What's Next in Setting Up an Emergency Fund?
Finding the best ways to save money that works for your situation is important. Once you become comfortable setting up an emergency fund, you can also set long-term goals, including saving for retirement or putting a down payment on a
home. Additionally, for long-term goals, consider investment and tax-efficient saving accounts. Automating transfers from your checking to your savings account can help you save without thinking about it. It can also prevent you from touching the money meant for saving. Moreover, you can also apply the 50/30/20 rule, where you put aside 50% of your monthly income towards your necessities (bills, groceries, mortgage), spend 30% on the things you want, and 20% towards your saving. Last, but not least, remember to aim for at least three to six months' worth of living expenses in your emergency fund as a safety net.