Tanza Loudenback* says the first step to any sound financial plan is setting up an emergency fund.
It’s no secret that many people struggle to save money, whether it’s because wages are low, debt repayment consumes our paycheques, or we’re overspending.
As a certified financial planner in training, I’ve learned that the number one step to a sound financial plan is setting up an emergency fund.
Before aggressively saving for retirement or investing, the very best thing you can do for yourself is build up a cash reserve.
An emergency fund is money you can access quickly if there’s a sudden medical emergency, your car needs a new transmission, you lose your job, or some other huge, unexpected bill lands in your mailbox.
For the vast majority of people, it’s not a matter of if something will happen that threatens your financial stability, but when.
Some people will disagree that everyone needs an emergency fund.
If you have more money coming into your bank account each month than you can spend, you have a trust fund waiting to be tapped, or you’re highly risk-tolerant, then you may prefer to put your unspent cash to work in the markets.
But here’s the reality: For the average person, an emergency fund is the greatest defence against high-interest debt and we simply can’t afford to risk it.
How much to save in an emergency fund
If you’re looking for a savings benchmark, it will depend on your monthly expenses and the stability of your income.
The US Certified Financial Planner Board of Standards teaches the following rules of thumb:
- If you’re a single-earner household, you need a minimum of six months worth of expenses saved.
- If you’re a double-earner household, you need a minimum of three months worth of expenses saved.
- If you’re a single-earner household with a second source of sizeable income, you need a minimum of three months worth of expenses saved.
Expenses includes both fixed and variable costs.
In other words, how much you spend in a regular month on everything that allows you to maintain your lifestyle — mortgage or rent payment, car, food, credit-card payments, etc.
Once you have a target number you’re working toward, it should feel more achievable than just saving a buck here and there.
If you do some number crunching, it’s easy to figure out how much you need to save every month, week, or day to get there.
If you can jumpstart your savings with a bonus or a tax refund, all the better.
Where to save your emergency fund
Starting from scratch and building up a four or five-figure savings account takes some discipline.
I recently started to treat my savings as an expense and set up direct deposits from my paycheque into a high-yield savings account at a different bank than where I keep my cheque account to avoid the temptation to dip into it for a non-emergency.
Saving off the top meant I never had to contemplate what I was going to cut out in order to save more.
I worked backwards in a sense — I picked a savings amount that would give me a solid emergency fund in less than two years and forced myself to live on what was left over.
The beauty of utilising a high-yield savings account for your emergency fund is that your money earns interest while it’s sitting there.
Interest can add a little boost to your savings — the more you put into the account, the more you’ll earn in interest.
And most importantly, your money will be right there when you need it.
It may seem impossible to save cash if you’re balancing other priorities, like paying off debt, but an emergency fund can’t wait.
Whatever amount you can afford to contribute, whether it’s $5 or $500, will make a difference.
At the end of the day, the most important thing is that you have at least some money to fall back on.
* Tanza Loudenback is a senior reporter at Personal Finance Insider for Business Insider. She tweets at @notsoTan_za.
This article first appeared at www.businessinsider.com.au.