Building an Emergency Fund

It was a dark and stormy night. Then things got really interesting when a tree blew over and crashed into my emergency fund … I mean my house.

The night was when Hurricane Irma hit Florida. I was lucky that the tree just tore up the back deck.

Millions of Americans were not so fortunate this hurricane season. If you ever wondered what “Save for a rainy day” meant, the double-whammy of hurricanes Harvey and Irma should have explained it.

The “Save” is an emergency fund. Not having one is like leaving your car parked in a forest during a tornado and hoping nothing heavy falls on it. Something is bound to happen eventually. Learning about emergency funds now, will hopefully prevent you from searching for credit card help later.

To avoid such disasters, the most commonly asked questions are “How do I build an emergency fund?” and “How big should it be?”

Let’s take the second one first.

How Big Should an Emergency Fund Be?

Traditional financial planners will tell you an emergency fund should be big enough to cover at least three months worth of expenses and ideally six. So, add up all of your monthly expenses including rent, car payments, student loan payments, groceries, gas, etc. Then multiply that number by three, and that will calculate how big your emergency fund should be.

But, you should actually have two emergency funds, one for short-term emergencies and another for long-term emergencies.

A short-term fund is for immediate emergencies, like a car repair or replacing a refrigerator. It should have $500 to $1,500.

A long-term fund is for emergencies that probably don’t have a quick fix, like losing your job, a lingering health crisis or major damage from a natural disaster.

Since such developments could mean a loss of income or big jump in expenses, the long-term fund should be large enough to cover at least three months of living expenses. Six months (or longer) is preferable. That will allow you to maintain your standard of living without having to rely on loans or high-interest credit cards.

How to Start an Emergency Fund

First, open two savings accounts – one for short-term emergencies and another for long-term emergencies.

Look for banks with a high annual percentage yield (APY). APY is interest that is added to your account. In 2019, that should be something around 2%. Check out some credit unions and a couple online companies like Ally Financial. Ally has an online savings account with rate of 2.2%, meaning if you had a $10,000 savings account (or emergency fund), they will pay you $220 per year.

It’s a good idea to open the savings accounts at a different bank than your checking account. Keeping some distance between checking and savings will hopefully limit the temptation to use the emergency funds for non-emergencies.

And unless you are lucky, you are going to need it for emergencies.

About 96% of Americans experience at least four “income shocks” during their lifetime, according to a 2017 study by The New School for Social Research.

An “income shock” is defined as a 10% or greater decline in pay due to a job loss or ill health. A severe shock is when you lose all income for at least a year. The study showed that 61% of workers had at least one severe shock by the time they reach age 70.

As to how many people are prepared for such shocks, the data is mixed. A 2017 report by Bankrate found that nearly six in 10 Americans didn’t have enough savings to cover a $1,000 unplanned expense.

But according to Bankrate’s Financial Security Index survey for June 2017, only 24% of U.S. adults said they have no money saved for short-term emergencies, and 31% said they have enough to cover six months’ worth of expenses.

Though the precise numbers are debatable, there’s no doubt millions of Americans are not prepared for the coming storm.

Reasons for Having an Emergency Fund

Financial issues, particularly debt, can create significant stress and mental health challenges. Having an emergency fund can help ease this debt stress, providing a buffer that allows you to handle unexpected expenses without adding to your financial burden.

There can be a lot of unexpected expenses, but here are a few of the big ones:

• Medical Bills: A broken forearm costs about $1,000, after examination, a cast and a free lollipop on the way out. If the injury requires surgery, the bill can skyrocket to $9,000. More than half of all insurance policies have at least a $1,000 deductible, according to a 2016 study by the Kaiser Family Foundation. If the insurance was bought on the Obamacare exchange, the average deductible was for a family was $2,600. That shows why medical debt is the leading cause of personal bankruptcy filings. In short, medical bills are enough to make you sick.
• Home Repair: The average American annually spends about 1% of the value of their home on repairs. So, if you own a $300,000 house, expect to spend $3,000 on just the routine stuff. If it’s not routine – like a new roof and major plumbing or electrical issues – the cost can quickly balloon. And if natural disasters strike (Hello, Irma. Harvey and forest fires in the West) the bills can be disastrous. My hurricane deductible was $7,800, meaning the money to repair my back porch came out of my pocket. But again, I escaped unscathed compared to most hurricane victims. Only 17% of homeowners in the eight counties most directly affected by Harvey had flood insurance. Those people will have to rely on government grants to rebuild, but such grants are capped at $33,000 per home.
• Unemployment: If you get laid off, fired or quit your job, the average length of unemployment was 24.4 weeks, according to the August 2017 jobs report. Almost 25% of American workers were unemployed more than 27 weeks. Unemployment benefits rarely make up for the lost wages. A six-month emergency fund will make standing in the unemployment line a bit less stressful.
• Pet Care: Your dog or cat can cost more to keep healthy than your son or daughter. A 2016 report by Health Paws Pet Insurance found that stomach ailments in pets can cost more than $6,000 to diagnose and treat. Heart surgeries run as high as $20,000. An ear infection can cost up to $250 for a visit to the clinic. That can really make you sick.

Now that you’ve got a taste of why you need an emergency fund, how do you get one?

Ways to Grow Your Emergency Fund

It’s all about momentum. Open a savings account and put $100 in it. That’s hardly enough to cover most emergencies, but it’s something to build on. Then take a look at some of these tips to grow your emergency fund and before you know it, you’ll be prepared for the next rainy day.

Here are other tips to bulk up your fund.

• Use Your Tax Return. The average tax refund in 2019 was $2,703. That’s more than enough money to jump start an emergency fund. Then each year take a portion of your return and add it to your emergency fund.
• Increase your income. You can find a part-time job that fits your schedule. The thought of working three extra hours a day might be depressing, but it beats the thought of not having enough money to save your dog’s hearing. You can also generate income through selling items on eBay or Craigslist.
• Cut expenses. There’s no shortage of options here, from carpooling to using coupons for shopping to eating out less to turning the thermostat up in the summer and down in the winter. You could stay home on your next vacation. With a little planning, a staycation can be just as fun and a lot less expensive. And the money saved would be a nice boost to your emergency fund.
• Keep the change. When you get some $1 bills after breaking a $20, drop a couple into a jar at home. When it’s full, deposit the money into your emergency fund. If you don’t carry cash, you can use a mobile savings app like Qapital, Acorns or Digit that makes automatic transfers.
• Move Checking funds into savings. The money in a checking account is most-often for immediate use and there could be times when we have more there than we need to handle monthly bills. Monitor your checking account. If there is a surplus there, move it over to savings where it can sit quietly, waiting for an emergency. Consider transferring it to a high-yield savings account, where it can grow steadily while remaining readily available for emergencies.
• Use a grocery shopping list. A grocery list is like a plan of attack. Without one, the forces of hunger and temptation are going to defeat you. Research shows people not only will purchase more food when they’re hungry, they’ll purchase more high-calorie junk food. So before venturing into the supermarket battlefield, have a healthy snack. Then write down the items you need and stick to that list. Feel free to make exceptions if there’s a great sale on dog food or other items. Just be sure you have a dog before making the purchase.
• Shop around for better rates on insurance and credit cards. Insurance is a hotly competitive market, so it pays to get quotes from as many companies as you can. Be open to combining your home and auto policies. With credit cards, it’s all about the interest rates. The difference between a 12% APR and a 22% APR can translate into hundreds of dollars annually. Call your credit card company and ask to speak to a supervisor. Then request that they reduce your interest rate or you’ll transfer your balance to a different card. If you feel that’s too confrontational, a counselor in a debt management program will do it for you. They work with creditors to get the lowest rates, then they combine your various debts into one monthly payment.

That can save you a substantial amount of money and improve your credit score. But whatever tack to you take, it will pay to remember things like Irma and Harvey. When you have an emergency fund, you’ll sleep a lot better on those dark and stormy nights.