When I talk with friends and clients about investing their money, I can be flexible. I listen to their needs and desires, and we make a plan that works for them. However, the one thing that I will not budge on is setting up an emergency fund. The reality is that we will all need an emergency fund at one time or another. It may not be today, this year, or even in five years, but most likely one day an emergency fund will prove useful.
Don’t be caught in an emergency without being financially prepared
An emergency is any situation that affects your health or capacity to earn money. It is not your daughter’s birthday, the Holidays, or a vacation. The importance of an emergency fund should not be ignored. The Federal Reserve conducted a study that found more than 25% of adults neglected necessary medical care in 2017 due to the cost. Having an emergency fund can help prevent this from happening to you.
Where to begin creating an emergency fund
There are many opinions on how much money you should put into your emergency fund, and there are many things to consider such as your rent or mortgage, car insurance, and child expenses. A general rule of thumb is to have three to six months savings put away. This number is highly personal to your situation. The amount of savings you need depends on circumstances such as if you are married, have children, or care for an aging parent. In which case, you may need to put more away than if you are single with no dependents. Do you have parents that can help you in a crisis or have other means of savings? If so, you may need less in your emergency fund. There are many emergency fund calculator tools that you can use to help determine your needs.
Beginning to save can sometimes feel overwhelming. One way to begin is to start slowly by just saving your extra change. If you have a few dollars or a handful of change at the end of each day or week, put it in a jar and start letting it accumulate. Additionally, if you put away just $20 a week, by the end of the year, you will have $1,000 saved for your emergency fund.
A tax refund is another excellent way to get a jump start on your savings. If you receive a tax refund, deposit that entire amount into your emergency fund. You can even have the refund directly deposited into your savings account.
Saving for an emergency fund is not an ongoing action. Set a timeline to hit your goal. When it is met, continually check the balance, and make sure you are prepared for any situation.
Where to put your emergency fund
In an emergency, you may not have the time to sell stock or other assets. The key here is to have quick, easy access to the money. However, do not make it so easy to tap that you are tempted to use it in non-emergency situations.
A basic savings account or money market account is really the best choice. Here the money is liquid and safe, but is not so easy as to tempt you to grab the cash for other items. Look for a high-yield account, meaning it pays higher interest rates than a traditional account. This way you are making money on your money. Remember to look for accounts that don’t have annual fees.
Get into the habit
Whether you begin with small deposits from extra change in your wallet, or start larger with a tax refund, the key is to make savings a habit. Set a realistic savings goal for each month and stick with it. Once your fund includes three to six months’ worth of savings, continue to save. If you must withdraw some of your account for an emergency, ensure you replenish it.
Creating an emergency fund is not necessarily a fun way to spend money, but the peace of mind it will bring to you will be worth it. Savings should be a priority so that you stay financially prepared and secure for anything life throws your way.
Claudia Mollerup-Madsen is Vice President and a Financial Advisor with the Wealth Management Division of Morgan Stanley in Houston.