The COVID-19 pandemic along with its after effects of high inflation have taught us many lessons, some we can agree and disagree on based on political viewpoints. One thing that everyone can agree on though is it showed how important it is to have a fully funded emergency fund. It seems so simple on the surface, but is it really? This article will show not only why its so important but also how to start an emergency fund.
Status of Americans finances
According to a CNBC article, at the end of 2020, several months into the pandemic, approximately 63% of Americans were living paycheck to paycheck. For those non math majors, that is 2 out of every 3 people. The same study showed it was only 53% of Americans before the pandemic. However, in 2019, the number was closer to 80%. Then a more updated number in 2023 showed it to be 58%. Clearly the number has fluctuated some. But, let’s look at it further.
70% said they feel stressed about their finances overall. Okay, not too surprising, given the economy we have seen, But perhaps the stat that caught my eye the most was related to having emergency funds
How many have an emergency fund?
Over half of respondents said they have nothing for an emergency fund. In previous studies during COVID,, I read that close to 80% couldn’t cover a $500 emergency and were concerned they had depleted their emergency funds.
The good news is during the pandemic, those that could save did more. The personal savings rate, or percentage of disposable income people save, soared to 33% in April 2021. It’s since dropped to 13%, per data from the U.S. Bureau of Economic Analysis, but is still higher than it has been in 4 decades.
However, more than a third of millennials, 37%, still said their credit card debt exceeded their emergency fund balance. That’s compared to 31% of Gen Xers and 18% of baby boomers who said the same.
Why you need to start an emergency fund
It makes sense why credit card debt has gone up. Look, stuff comes up, life happens. If you don’t have an emergency fund, how are you going to pay for it?
As a homeowner, I’ve loved the ownership and fact that I am building equity. But, make no mistake about it, it comes at a cost.
We have had several things come up that hit our bank accounts. A couple years ago, a simple remodeling project I was doing resulted in water leak upstairs that ended up in our newly finished basement. We had to have the ceiling and walls gutted and redone. Luckily, insurance covered it, but still our deductible applied. $1,500 out the window that wasn’t planned.
Then, just as I write this, we went to open our garage door and it wouldn’t. The torsion coil spring broke. There was another $300 to repair.
I haven’t even mentioned the medical bills I saw that were unplanned. We are talking in excess of $10,000. Life happens! You must be prepared to pay for these things and not resort to credit cards.
Tips on how to start an emergency fund
- Compile a list of things that could theoretically come up: Look, everyone has different circumstances. If you are a homeowner, the list of potential items may be longer. If we buy insurance to cover ourselves, why would you not build up a fund to cover the deductible if a claim were to be filed?
- Save over time: It doesn’t have to be fancy, but when you go to review your budget, assign a certain amount each month to an emergency fund. Have an older car and it might be coming due for some major maintenance? Lets say you know new brakes possibly will be needed in the next year. If you estimate it will cost $2,000, assign $166 a month to this fund. Then, a year from now if your brakes are still good, you have a fully funded amount to cover them when they do go bad.
- Use windfalls to your advantage: Find yourself relying on that tax refund, or your annual bonus? Make a plan to put all of that into an emergency fund bucket. I know it may sting as you use that money for vacations or luxurious things. But remember, the goal is to reduce your stress, and this should be an easy step.
- Change your mindset: we need to get away from thinking it is okay to just charge something to a credit card when it comes up. Often big emergencies come with a large dollar amount, and in turn if they get put on a credit card often means people will carry that balance forward, which means, you guessed it, lots of interest.
How much do I need in an emergency fund?
The amount you should save for an emergency fund depends on your situation. Think about the most common kind of unexpected expenses you’ve had in the past and how much they cost. This may help you set a goal for how much you want to have set aside. A good rule of thumb is to have 3 to 6 months worth of living expenses saved. The 3 to 6 months is a general guideline, I personally strive for 6 months of cash, but others may opt for at least a year.
If you’re living paycheck to paycheck or don’t get paid the same amount each week or month, putting any money aside can feel difficult. But, even a small amount can provide some financial security.
Conclusion
An emergency fund is an essential part of financial planning. It can provide a sense of financial security, protect you from financial shocks, and help you avoid going into debt. Having 3 to 6 months’ worth of living expenses saved is a good goal to aim for. By creating a savings habit, managing your cash flow, and using windfalls to your advantage, you can build an emergency fund that gives you peace of mind and financial stability. I’m curious, what do you consider to be a good rule of thumb in your family or situation? Leave a comment below!
