It’s not something we like to think about, but life is full of unwelcome surprises. If you’re not prepared, even everyday surprises, such as a car breakdown, household repairs or a medical emergency could become full-blown financial disasters.
Which is why building an emergency fund to insulate you from financial surprises is important no matter the size of your paycheck.
Unfortunately, millions of Americans don’t have the savings to pay for even modest unexpected expenses.
“Despite some signs of improvement overall, 46% of Americans say they struggle to meet emergency expenses of $400, and 22% of workers say they are juggling two or more jobs,” Federal Reserve Board Governor Lael Brainard said in regard to the board’s “Report on the Economic Well-Being of U.S. Households” last year.
A quick look at the average cost of common mishaps should convince even the most optimistic of people that having an emergency stash tucked away is a must.
How much should you save in your emergency fund?
You should save enough to cover your living expenses for three to six months. How much is that? It all depends on how big your family is, where you live and your standard of living.
In the United States, a family with two parents and two children require about $5,466 a month on average to maintain a basic standard of living, according to the Economic Policy Institute (source). So, a family of four that follows the recommendation will aim to have $15,000 to $30,000 in its emergency fund.
A single adult with no children will need about $2,370 a month, which means an emergency fund of $7,000 to $14,000.
A married couple with no children needs about $3,305 a month, so they should try to put aside $10,000 to $20,000.
How to get started
In my experience, the key to building an emergency fund is automation. I advise people to set up a separate account and try to put some friction between that account and your main checking account. By friction I mean you should make it slightly inconvenient to access your emergency savings or stop the automatic contributions.
Set up an account at another bank
To provide the right amount of friction, set up the savings account with a provider that is not your primary bank. It will make the money that accumulates there somewhat out of sight and also adds some additional friction to the process of getting the money out, as you’ll need to transfer it back to your main account. A good option is Discover Bank who offer a high yield no fee savings account.
Set up direct deposit or recurring transfers
Once you have the account, it’s time to set up automated transfers for every payroll period. Ideally you should set up the automated transfers as part of your employer direct deposit as this will make it a little more difficult to turn them off (added friction). Alternatively, you can set up recurring transfers that are timed to your payroll directly in your online banking system. When selecting an amount to save, try to save at least 20% of your after-tax income, but any amount is better than nothing – even if it’s $20 per pay period.
Download an automated savings app
Another way to save is to download an automated savings app such as Acorns. These apps connect to your bank account to monitor your transactions. They round up each transaction to the nearest dollar and micro-deposit the difference into your savings. The money is invested and grows over time behind the scenes. This can be an excellent way to supplement your savings plan.
Monitor and reduce unnecessary expenses
Of course, you can’t save anything if you’re spending more than you’re earning. So, the first place to start is with a budget. There are great tools such as Mint that pull down all your transactions from your bank accounts, credit cards and loans to help you see where you’re spending your money. This can help you be more responsible about spending and to cut unnecessary expenses.
These are just a few ways you can use automation to kick start your savings. If you’re serious about starting an emergency fund, follow the steps I’ve highlighted above and you’ll find yourself with a war chest in no time.