If an unexpected $500 expense came up right now, how would you pay for it?
Most Americans would simply use a credit card, and pay it off later. Is that the best option? Your short-term problem is solved, but not only will you be paying back the $500 over time, you’ll have the extra expense of credit card interest. When the next ‘emergency’ arises, and you’re still paying off the first ‘emergency,’ you may find yourself in a vicious cycle of debt that can be hard to escape.
If you prepare for unexpected expenses by building an emergency fund, you can better protect yourself against a future financial crisis.
The ideal amount to put away will vary for each household, but 3 to 6 months of expenses is typically recommended. If your job situation is uncertain, it’s best to have a larger sum, such as 9 to 12 months. At the very least, $1,000 should be set aside until you can afford to put away more.
How do you start building an emergency fund?
If you already have some money in savings, set some aside right away to use strictly for emergencies. Many banks allow you to have separate savings accounts, so dedicate one for emergencies only, that you’ll only tap into when you need it. If you don’t have any money to put in right now, start small – $50 a month – and have it deposit directly into savings the day you get paid. If you don’t have to think about it, and you don’t see the money, you’ll begin to not count on it as part of your monthly income and it can build interest quietly until you need it.
If $50 a month seems like too much, here are some ways to make it work for you:
Once you do tap into your emergency fund, don’t forget to replenish it as quickly as possible. It should be a priority over saving for college, retirement, or any other type of savings. Again, maintain 3 to 6 months of expenses if possible.