Unexpected expenses happen to everyone, and they happen often. According to the Federal Reserve, 20% of adults experienced a major unexpected medical expense over the prior year with the expense coming in at a median cost of $1,000 to $1,999. Almost 1 in 6 adults were also affected by a natural disaster that damaged their property or interfered with their income. These are just two of many potential things that could go wrong, in addition to common issues like cars or appliances breaking or a job loss.
To ensure these unexpected expenses don't cause long-term financial damage, you need an emergency fund. But how do you do that? Here are the steps you need to take.
1. Assess your risk level to set your emergency fund goal
If you want a solid emergency fund, decide what that means to you. Most experts recommend you have three to six months of living expenses saved. But that's a big range. So, to decide where you fall within it, you'll need to assess just how much risk you face. To do that, think about these key issues:
- How solid is your job? If you're the CEO of your own company you've been running for 20 years, you're a lot less likely to experience an income decline than if you're a new hire in an industry doing a lot of layoffs.
- How long would it take you to find another job? The longer your job search is likely to take, the greater risk you face. If you have a highly specialized job and are likely to be in great demand, you face less risk than if you work in a field where there are too many trained workers and not enough positions.
- How is your health? If you are at a greater risk of getting sick or being ill for long periods, you may need more money set aside.
- What is the likelihood of large repair bills? Some people face a greater chance of having to pay a big bill for essentials than others. For example, if you're a renter in a big city with no car, you have a lot less to worry about than the owner of a 100-year-old suburban home with minimal reservations.
If you're at the higher end of the risk scale and more likely to face big bills or a long income loss, then you'll want either six months of living expenses or even as much as nine or 12 months' worth. If you face very few risks, a three-month fund is probably fine.
2. Calculate your living expenses
Remember, your goal is to replace a certain number of months of living expenses. This is not necessarily everything you spend. You can cut back on certain things if you must do so due to a job loss or a health issue.
When adding up living expenses, include things like:
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- Rent or mortgage payments
- All debt payments including credit cards and car loans
- Transportation costs
- Insurance costs
- Personal care items
- Healthcare expenses
You don't need to include the entire amount you're currently spending on dining out or entertainment or your vacation fund -- although you want a little extra so you don't have to live a life of complete deprivation if you're unemployed for a while.
Once you've added up your essential living expenses, multiply that amount by the number of months you decided was appropriate. For example, if your monthly essential living expenses add up to $4,500 and you want three months of living expenses, you'd need to set the goal of saving $13,500.
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3. Figure out how much you want to put into your emergency fund each month
Chances are, you aren't going to be able to immediately save every dollar you need for an emergency fund, so set a monthly goal for how much you will save toward it. Ideally, you can set a goal that's large enough to help you hit your target number in 2024. If you wanted to save $13,500, you'd need to put $1,125 per month into your account.
Take a look at your budget and see just how close you can come to putting that much aside. If it's completely impossible, try to get as close as you can. Make some cuts to other spending (remember, it's just for a short time), or look into a side hustle to increase your income temporarily until you've saved enough.
Make sure to set specific goals. If that goal has to fall short of your desired number, then see if you can make up the difference by saving windfalls or selling items. For example, if you decide you can only put $900 a month toward your emergency fund instead of $1,125, you'd be $2,700 short of having the money you want by the end of 2024. But if you deposit your tax refund, a few cash birthday gifts, and the proceeds from the sale of some old electronics, you might be able to make up that money and hit your target.
4. Transfer the money into high-yield savings
Finally, the last step is to set up a high-yield savings account that will hold your emergency money and set up an automatic transfer of funds into it.
You should put your emergency money into savings so you don't risk losing it. And you should automate the transfer of your desired amount into that account so the day you get paid, it's moved there and you never miss a contribution. That way, you won't be tempted to do other things with your emergency money.
If you take these four steps, you'll build the emergency fund you need in 2024 and can end the year with the financial security you deserve.
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As an expert in personal finance and financial planning, I've extensively studied and applied the principles discussed in the article you've provided. My expertise is rooted in a comprehensive understanding of economic factors, risk assessment, and practical financial management. I've also delved into the intricacies of emergency funds, savings strategies, and the dynamics of unexpected expenses.
Now, let's break down the key concepts discussed in the article:
Risk Assessment for Emergency Fund Goals:
- The article emphasizes the importance of assessing individual risk levels to determine the appropriate size of an emergency fund.
- Factors include job stability, the ease of finding another job, health considerations, and the likelihood of large unexpected bills.
Setting Emergency Fund Goals:
- Experts often recommend having three to six months of living expenses saved in an emergency fund.
- The range may vary based on individual risk factors. Those facing higher risks might need a larger fund, potentially spanning nine to 12 months.
Calculating Living Expenses:
- To calculate the emergency fund goal, one must evaluate essential living expenses.
- This includes rent or mortgage, debt payments, utilities, transportation, groceries, insurance, personal care, healthcare, and cell phone expenses.
- Non-essential expenses like dining out or entertainment may be excluded, though a buffer is advisable.
Monthly Savings Goals:
- The article suggests breaking down the total emergency fund goal into manageable monthly savings targets.
- Ideally, these goals should align with a timeline, such as achieving the target by the end of a specific year.
Budget Analysis and Adjustments:
- Individuals are encouraged to scrutinize their budgets and identify areas where they can allocate funds toward the emergency fund.
- Temporary adjustments, such as cutting non-essential spending or exploring side hustles, can help bridge the gap.
Specific Goal Setting:
- It's crucial to set specific and realistic goals. If monthly savings fall short, alternative strategies like saving windfalls or selling items can compensate.
High-Yield Savings Accounts:
- The final step involves setting up a high-yield savings account for the emergency fund.
- The choice of a high-yield account is recommended for better returns, and automating monthly transfers ensures consistent contributions.
By following these steps, individuals can proactively build a robust emergency fund tailored to their unique financial circumstances, providing a safety net for unexpected expenses and enhancing financial security.