SUMMARY: When financial trouble strikes, falling deeper into debt is one thing you want to do your best to avoid. Make sure you have an emergency fund set up to stay protected.
By now, you’ve probably heard that the first step to a solid financial plan is to set up an emergency fund—an easily accessible account with enough money to handle expenses that pop up unexpectedly. Your car engine dies, your partner needs a trip to the emergency room, your boiler needs replacing or, most disruptive of all, you lose your job.
Below is a deeper dive into the why and how of setting up an emergency fund.
1. Why start with an emergency fund?
When financial trouble strikes, falling deeper into debt is one thing you want to do your best to avoid. The cushion provided by an emergency fund can keep your head above water during a time of crisis without relying on high-interest loans or credit cards. If you already have significant debt, this becomes even more important.
2. How much do I need?
A good starting point is to put away three to six months of living expenses for you and your family. This can be an essential tool to boost your unemployment benefits while you look for a new job or cover basic monthly expenses while a family member receives medical treatment.
If you don’t have that much at the ready, don’t panic. Even a few hundred dollars can help with small things that can otherwise turn into major headaches. Start where you can and increase a little every month.
3. Where do I put it?
Your emergency fund needs to be in an account that’s accessible at a moment’s notice, be it a traditional checking or savings account, a money market account or treasury bonds. Make sure it’s separated from the money you rely on every day. This avoids the temptation to use it for daily expenses.
4. How do I grow it?
It’s not enough to put a lump sum down and let your bank’s interest rate add pennies at a time. You need to contribute monthly, or as often as possible.
So, how to carve regular contributions out of a tight budget?
- Set it and forget it. Let the wonders of modern banking remove the pressure and set up automatic transfers into your emergency fund directly from your paycheck.
- Put extra money away. Have money leftover from your paycheck at the end of the month? Into the fund it goes.
- Round up. Extra bills or coins from buying your morning coffee? Keep them separate and periodically move them into the fund. Don’t carry cash? There’s an app for that. Many of them, actually.
- Use your tax refund. Assuming you get a refund, think of it as the IRS’ annual contribution to your emergency fund.
- Earn more money. If time permits, look into a second job or join the gig economy.
- Trim expenses. If you don’t have extra money each month, then take a careful look at your monthly bills and see where you can save. Do you really need cable, or can you cut the cord and go streaming? How about a carpool to work? Or eating out less often?
- Check in regularly. Take a close look at how it’s going every quarter or so, particularly if you’ve had to dip in recently. Make adjustments as needed to keep things on track.
5. What doesn’t count as an emergency?
As necessary as you may think they are, a weekend getaway over Christmas or a detox at the spa after a stressful month probably shouldn’t qualify as emergencies. Likewise, a great deal at the car dealership on a new truck or even an increase in your insurance premiums.
6. Your first step to a solid financial plan
At some point or another, everyone will have an unanticipated expense that requires a quick infusion of cash. An emergency fund is the ideal way to handle that situation while avoiding additional debt and a possible hit to your credit score.
It should also be everyone’s first step in a comprehensive plan that includes debt service, a 401(k) or IRA and retirement savings. A financial cooperative like TDECU can provide personalized guidance that fits your resources and goals. Get started today with our road map to retirement.