By Rodney A. Brooks
No matter how old you are, or which life stage you are in, you need an emergency fund. And you need it even before you start saving for your future.
So, what exactly is an emergency fund and why is it so critical? Consider it to be the buffer that keeps you going when stuff happens 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 advisors say you need in case you lose your job.
In real life stuff happens. An emergency fund for most of us is cash you would need in a real emergency – your car breaks down; your HVAC stops operating during a heatwave, or you need a new hot water heater.
The truth is that 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 a $1,000 unexpected expense.
- Only 44 percent would be able to pay from savings
- 20 percent would pay using a credit card
- 15 percent would pay it but cut spending in other areas
- 10 percent would borrow it from friends
- 4 percent would take out a personal loan
According to the Pew Research Center, fewer than half of Black Americans said they had an emergency fund and they have taken multiple steps to make ends meet. That survey also said that, unsurprisingly, Black Americans typically experience higher levels of economic insecurity than Americans overall. Remember the average net worth of a Black family is only 1/10 of a white family ($17,100 vs. $171,000).
Are you prepared to pay for the unexpected without having to resort to costly payday loans or high-interest credit cards? The average credit card interest was 19.13 percent for new offers and 15.13 percent 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 of everything are still rising. A set of new tires can cost you $600, or more, though costs will vary with the model and use. Plumbers can cost $45 to $150 an hour with minimum service rates.
How much you need in that emergency fund depends on your personal situation. But you need to have some savings to get you through those tough crises.
Here’s how you can build an emergency fund.
Start by creating 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. Don’t carry it around, put it in a book or in a sock drawer. When you get it up to a couple of hundred, put it in a bank savings account. You won’t earn much on the money, but you want it in cash.
Set aside your tax refund or pay raise instead of paying bills.
Cut out one restaurant meal a month or one weekly visit to Starbucks and instead put that money into emergency fund savings.
Get a temporary side hustle or part-time job. Save until you have $1,000.
The reason you want to begin an emergency fund before you begin saving/investing: You don’t want to pull money out of a mutual fund or retirement fund to pay for an unexpected emergency. Not only will you be messing with your investment return, but you also may also face tax consequences.
You must consider that emergency fund to be separate, and only your first step towards and investing for your future and your retirement.