Here’s the Real Reason You Need an Emergency Fund—And How To Make It Happen
The most commonly doled out piece of financial advice may well be, “Start an emergency fund.” You’ve undoubtedly been on the receiving end of this wisdom before, but even though it’s valid advice, it can be hard to implement. This is especially true when no one actually tells you why you should invest in emergency savings, or how exactly you go about building up that financial safety net. At SoFi, we’re committed to helping our members plan for their future—and part of maintaining secure financial footing is working to ensure that you can handle the unexpected expenses life brings.
Imagine if tomorrow your mechanic told you that you needed to replace your brake pads—to the tune of $500. Would you be able to cover that expense without reaching for a credit card? Would you be able to pay the bill without reorganizing your monthly spending to account for the extra cost? If you’re doing mental gymnastics to figure out how you’d pay for a $500 financial emergency, you’re not alone. In fact, six in 10 Americans don’t have enough savings to cover a $500 or $1,000 emergency (which means their emergency fund is effectively their credit cards). And that’s not the only reason an emergency fund is crucial—it can also keep you afloat if you suddenly lose your job or need to take unpaid time off work. It should be used to cover the out-of-ordinary expenses, keeping you out of debt and your phone number out of the hands of creditors. With that in mind, here’s what you need to do to start building your emergency fund today.
Aim to save three to six months’ worth of expenses
In the grand scheme of life, $500 is a relatively small amount of money. A car accident, injury, or job loss may well bring you much higher out-of-pocket expenses. And unfortunately, surprise expenses have a tendency to pile up. This means that you shouldn’t just stick $500 in your savings account and call it a day.
To calculate how much you need to save, look at the deductibles your auto and health insurance have you pay in the event of an accident, emergency room visit, or ambulance ride. That cost is the very minimum amount of money you would have to shell out for a minor misfortune. In general, three to six months’ worth of expenses is a good base for determining how much you would need if you lost your job, were temporarily disabled, or had to take time off to care for a sick family member. While you could add up all your monthly expenses, a faster way to make this estimate is to start with your take-home pay, subtract any money you’re already saving, and subtract money you don’t need to spend. What’s left are your monthly expenses. Another benefit of this method is that it gives you the opportunity to see what spending you can live without, which you can cut out of your budget now and start weaving into your safety net.
Start small and stockpile when you’re able
Most young professionals don’t happen to have three to six months’ worth of income just sitting in their checking accounts, waiting to be moved to an emergency fund. Instead, you’ll need to figure out exactly how to fund that goal. I recommend starting your emergency fund with any minor windfall—a tax refund, bonus, or even a birthday check from Grandma. After you’ve got a base, automate your money management account to transfer a small sum of money to your emergency fund each pay period. It’s okay to take your time building up your fund, but if you don’t take the first step and start, you’ll never get ahead. Remember, you can use your money to buy something that will make you feel rich in the moment, or you can save it and increase your wealth over time.
Keep your savings liquid
The whole point of an emergency fund is that it is easily accessible money, which means it needs to be liquid. Interest rates are often fairly low for savings accounts, but if you shop around, you’ll find some out there that pay over 1%. As you look, try to make sure the account is FDIC insured as well.
As you grow your emergency fund, consider keeping a portion of the money in a savings account, and putting the rest into a low-risk investment, like a short-term bond fund or ETF. For example, you could invest some of your emergency savings in a conservative portfolio, while keeping the rest readily accessible in a savings account. This is a portfolio of investments, so it can lose money, but it is designed to yield more than a savings account and can potentially also go up in value.
If you need motivation, try this experiment
One of the biggest challenges you’ll face in saving for an emergency fund is motivation. If you find yourself tempted to spend your yearly bonus on new car or a truck’s worth of fancy seltzer water, try this instead: For one week, live on the money you’d get if you filed for unemployment in your state. This is no easy task, and it will give you an idea of exactly what you’re saving up to avoid. If you make it a week, consider if that’s really what you want to go through if you lose your job with no backup in place. Once you commit to focusing on your emergency fund, use the money you didn’t spend that week to start your account.
While saving an emergency fund is one of many competing financial priorities, having a cushion to catch you when you fall can prevent a minor calamity from spiraling into lasting debt. The toughest part is getting started and staying motivated. Just remember, you walk 10 miles by walking 10 feet at a time.
Building your emergency fund is a huge accomplishment, and one that proves you’re taking your financial future seriously. Keep preparing for what’s to come by learning more about SoFi Invest.
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