By Rodney A. Brooks
No matter your age or life stage, you need an emergency fund. And you need it before you even start saving for your future.
So what is an emergency fund and why is it so essential? Think of it as the buffer that keeps you going when things happen without having to resort to high-interest credit cards, payday lenders, and friends.
To be clear, I’m not talking about the three to six months of living expenses that financial advisers say you need in case you lose your job.
In real life, things happen. An emergency fund for most of us is the money you would need in a real emergency – your car breaks down; your HVAC stops working during a heat wave or you need a new water heater.
The truth is, less than half of Americans would have enough savings to cover a $1,000 emergency expense. Bankrate, a consumer finance company, asked in a survey “How would you pay for an unexpected expense of $1,000.
- Only 44% would be able to pay with their savings
- 20% would pay with a credit card
- 15% would pay for it but cut spending in other areas
- 10% would borrow it from friends
- 4% would take out a personal loan
According to the Pew Research Center, less than half of black Americans said they had an emergency fund and took several steps to make ends meet. This survey also found that, unsurprisingly, black Americans generally experience higher levels of economic insecurity than Americans overall. Remember that the average net worth of a black family is only 1/10 that of a white family ($17,100 vs. $171,000).
Are you prepared for the unexpected without having to resort to expensive payday loans or high interest credit cards? Average credit card interest was 19.13% for new offers and 15.13% for existing accounts in the second quarter of 2022 according to WalletHub.
Things are worse since the pandemic. Inflation is rampant, there are shortages everywhere, and prices for everything continue to rise. A set of new tires can cost you $600 or more, although costs vary by model and usage. Plumbers can cost between $45 and $150 per hour with minimum service rates.
The amount you need in this emergency fund depends on your personal situation. But you must have savings to get through these difficult crises.
Here’s how you can create an emergency fund.
Start by setting a budget. See how your income and expenses match up and where you can save.
Set a reasonable financial goal for your individual emergency fund.
Set aside $20 a week when you have it, or $10 when you don’t. Do not carry it, put it in a book or in a sock drawer. When you get to a few hundred, put it in a bank savings account. You won’t earn much on cash, but you want it in cash.
Set aside your tax refund or pay raise instead of paying your bills.
Cut out one restaurant meal per month or one weekly visit to Starbucks and put that money into an emergency fund instead.
Get a temporary job or a part-time job. Save until you have $1,000.
The reason you want to set up an emergency fund before you start saving/investing: You don’t want to take money out of a mutual fund or retirement fund to pay for an unexpected emergency. Not only will you be gambling with your return on investment, but you could also face tax consequences.
You should consider this emergency fund as separate, and only your first step towards and investing for your future and your retirement.