By now, we hope you’ve realized that emergency savings is a crucial part of your personal financial plan. Emergency funds can keep you out of debt, cover unforeseen life circumstances and give you a lot of financial peace.
Unfortunately, it’s a lot easier to talk about emergency savings than it is to actually make it happen in your life. Setting aside thousands of dollars for some unnamed emergency is a tough order for most people to fill. But we have some tips that will help take the sting out of it.
1. It’s okay to go slow.
One of the most intimidating things about emergency savings is the amount of money that experts recommend you have on hand. For most people, that’s going to be several thousand dollars; for families, it could be tens of thousands of dollars. Chances are that if you haven’t been a life-long saver, you don’t have anywhere close to that much money on hand.
I remember the feeling well. The first time that I took a financial class at church, and the teacher said that I should have three months’ worth of income in savings, I nearly panicked. I had nothing close to that, and no clear path to getting it. When I raised my hand and asked how on earth I was supposed to come up with that much money, he said “One step at a time.”
The point here is that while the ultimate goal of your emergency savings is a pretty big number, it’s okay to start small. It may take you several months — or even several years — of consistent savings to get there. Along the way, you’ll probably have some setbacks. But if you’re diligent, one day you’ll look up and realize that your emergency account is fully funded. And I can tell you from firsthand experience that it’s a very good feeling.
2. Make savings a line item in your budget.
Most people know that savings is something they should do. But for many, it never materializes, because they don’t intentionally set aside part of their income to make it happen. The remedy for this is to build emergency savings into your budget.
Budgets are the best tools that we have to plan the way that we’ll spend our incomes. When you’re making out a budget, you may find that you have more money coming in each month than what you need to cover your expenses. That’s a fun moment, and it would be easy to treat the rest as fun money. But until you have a fully-funded emergency account, you should budget most of that excess money for savings.
Make savings a line item in your budget, and treat it just like any other necessity that you’re paying for. After all, isn’t saving for emergencies just as important as paying your car insurance?
When you make savings a part of your budget, it quickly becomes a habit. You can even set up automatic bank transfers to take money from your checking account to your savings account every month, so that you’re not tempted to spend the money on other things. Put these methods in place, and you’ll be surprised just how fast your emergency fund grows.
3. Use separate bank accounts.
Speaking of bank accounts, it’s really important that you keep your emergency fund in a savings account that is separate from your main checking account. There are two big reasons for this:
First, keeping your emergency fund separate from your checking account makes it very easy to see how much money you have in both. If you have hundreds or thousands of extra dollars floating around in your checking, it’s very easy to get confused about what money is for what purpose. The risk is that you may misread your balance someday, and spend part of your emergency savings because you thought you had enough money in checking to cover the big purchase you wanted to make.
Second, savings accounts accrue interest, which helps to build your emergency balance even faster. Granted, today’s interest rates are so low that the money you make from interest will be negligible. But once the economy stabilizes and rates return to normal, you might be able to make several percent a year on your savings. A $10,000 savings account will earn $200 each year if interest rates are 2%. When I first started my emergency savings, I used Emigrant Direct (an internet bank), which was offering interest rates of 4.75% at the time. Though I’m not earning anything close to that now, I’m keeping my emergency savings there for the day when interest rates come back to normal.
4. Keep your emergency savings OFF-LIMITS.
The whole point of an emergency fund is to protect you during an emergency. So you have to discipline yourself to consider that savings account off-limits. You shouldn’t dip into that extra cash to take a nice vacation, to buy an engagement ring or to enjoy other big-ticket purchases. This money is set aside for a reason. Even though it’s yours, it’s not yours to spend.
The obvious exception is that it’s okay to spend from your emergency fund to help cover emergencies. If you have a car wreck, a medical situation, an unforeseen home repair, a surprise tax bill or other similar expenses, then feel free to use your emergency fund to cover them. That’s what it’s there for.
Over the years, I’ve dipped into my emergency fund to cover a variety of things, from big dentist bills to car repairs and other big expenses that I wasn’t able to handle out of my monthly budget. And while at first it feels like a little bit of a bummer — taking money out of the emergency fund sets you back a little bit in your march toward your final goal — every time I’ve been glad to have the funds available. Without those savings, these small emergencies would have added a large amount of stress to my life.
In the end, it may take you several years to reach your goal in emergency savings. That’s okay. The most important thing isn’t hitting that number quickly, but having the discipline to make emergency savings part of your monthly financial life.
Photo by Images of Money. Used under Creative Commons License.