Your Emergency Fund: Why, How and How Much

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Feb 24, 2021
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Whether youā€™re putting money aside for a down payment on the perfect house, gearing up for your dream vacation, or just ensuring that youā€™re financially secure, saving money is important. Creating and growing your standard savings, however, is only one component of a strong financial plan. You also need to be prepared in case of an emergency.

When unexpected expenses come up, you could put the charge on your credit card. But if you canā€™t pay it off when your statement is due, youā€™re left carrying a balance and paying interest. Alternately, you could dip into your general savings, but then that would take money away from a goal, such as a vacation or your retirement.

Rather than risking debt or taking money from your savings goals, create an emergency fund. By setting up a separate savings account devoted solely to emergencies now, before a financial emergency hits, you can protect yourself from the financial fallout of unplanned expenses. Here are five ways to get financially prepared for an emergency.ā€

1. Track Your Incomeā€

Building your emergency fund starts with creating a budget, and that means tracking how much money you earn.

Record all of your income sources, including your full-time job, your partnerā€™s full-time job, your side hustles, and any other incomes you may have. Add all of your income sources together to determine your monthly income. Be sure to set aside any taxes that will need to be paid and deduct them from the final amount before you begin budgeting.

You have several options for recording your income. You can record your numbers with a dedicated Excel spreadsheet or specialized accounting software for easy reference and calculation, or you could simply jot them down in a notebook. However you choose to record your income, itā€™s critical to know how much money you have to work with when determining how much you can spend and save each month.ā€

2. Track Your Expensesā€

The next step to budgeting for your emergency fund is tracking your expenses.

You have two types of expenses: fixed and variable. Fixed expenses donā€™t change from month to month and typically include such payments as:

  • Rent or mortgage
  • Homeownerā€™s or renterā€™s insurance
  • Car insurance
  • Life insurance premiums
  • Health insurance
  • Loan payments

Variable expenses, on the other hand, fluctuate each month. They consist of your daily spending decisions and typically include such things as:

  • Entertainment (concerts, movies, etc.)
  • Groceries and dining out
  • Clothes
  • Credit card payments

Like tracking your income, tracking your expenses can be done manually, entered into a log on your computer, or saved into an app. It all depends on your financial needs and personal preferences.

3. Figure Out How Much You Needā€

Once you have your income and expenses recorded, youā€™ll need to figure out how much you should put into your emergency fund.

Some say that having the equivalent of one to two months of income saved up is enough to cover most emergency needs. Many financial experts, however, recommend that you save up anywhere from three to six month of living expenses. This may seem like a significant amount, but some financial emergencies, such as medical bills or job loss, are expensive. You need to make sure that youā€™re prepared.

According to the US Bureau of Labor Statistics, households in the Philadelphia metropolitan area spent an average of $70,813 per year in 2017 to 2018, or $5,901 per month. With the advice of financial experts in mind, that means the average household in Philadelphia should have at least $17,700 in emergency funds.

This may sound like a lot, but itā€™s money youā€™ll be grateful to have in the case of illness, injury, car troubles, or sudden unemployment. The rapid spread of the COVID-19 pandemic has been an unpleasant reminder for many that you can never fully anticipate events that will impact your finances. Now more than ever, itā€™s clear how important it is to set aside enough money to keep you afloat during turbulent times.

To figure out the minimum that you should stash into savings for your emergency fund, simply calculate your monthly expenditures and multiply them by three. Then, you can start working toward your emergency savings goal.

If you donā€™t have that kind of extra funding just yet or if youā€™re paying off existing debts, financial advisor Dave Ramsey recommends starting with a fund of $1,000. As you nail down your budget and make adjustments, you can begin saving more.

4. Make a Habit of Saving

Itā€™s one thing to say youā€™re going to put money away for your emergency fund. Itā€™s another to actually follow through. To effectively build your emergency fund, you need to get into the habit of saving. These best practices can help you improve your saving and spending habits.

Build Savings into Your Budget:
When you sit down to create your budget for the month, create a category specifically for savings. Create subcategories for each of your savings goals such as a destination vacation, a car, or your emergency fund.

ā€Save First, Then Spend: Before you start allocating monthly funds toward expenses, set money aside for your emergency fund and other savings goals first. Known as reverse-budgeting, saving first prioritizes saving and can help you to cut back on impulse purchases.

Automate Your Savings:
If youā€™re worried about forgetting to set money aside for savings or being tempted to spend your income elsewhere, donā€™t hesitate to automate.

Set up automatic transfers with your bank so that when your paycheck hits, a portion of it goes immediately to savings. This way, the work is already done for you and you donā€™t even have to think about it. Make sure that you take these transfers into account when creating your monthly budget so you donā€™t mistakenly think you have more in your checking account than you do.

5. Limit Your Spending

A major benefit of creating a budget is that it allows you to take a good look at how youā€™re spending your money. That latte a few times a week before work might not seem like a big deal at the time, but when you look at your overall monthly spending, they really add up.

If you find that youā€™re not meeting your savings goals, itā€™s time to limit what you spend. Cutting down on spending may seem difficult, but there are plenty of ways to reduce what you pay for variable expenses and luxuries, such as:

  • Making your morning coffee at home and taking it with you in a thermos
  • Packing lunch for work instead of eating out
  • Planning your meals ahead of time
  • Writing a grocery list and sticking to it
  • Getting rid of subscription services that you donā€™t use anymore
  • Reducing your cell phone plan to include only what you need
  • Comparison shopping before making major purchases

The goal is to cut back on unnecessary spending so that you can create a comfortable emergency fund. While you might have to make some sacrifices in the beginning, especially if you have other debts to pay off, this doesnā€™t mean you canā€™t have any fun.

Instead of going out to fancy dinners several times a month, make one at home. Rather than meeting up with friends at the bar, invite them over for a potluck and game night. You may even find that the cheaper (or free!) alternatives to the things you used to do are a lot more fun!

ā€Reach Your Emergency Fund Goalsā€

Dealing with an emergency is always a challenge, but itā€™s easier to manage when youā€™re prepared. Firstrust Bank is here to help members of the Philadelphia community with all their financial needs, including budgeting and building an emergency fund.

Our Firstrust Financial Wellness courses and Personal Financial Management tool can help you more effectively plan your finances and work toward hitting your emergency fund goals. The app provides you with a visual overview of your spending and detects patterns in your behavior. You can create transaction categories and subcategories, including ones for savings and your emergency fund, to help you stay organized. By linking all of your accounts to the tool, you can see all balances and transactions in one convenient location.

We all like to think that weā€™ll never be faced with an emergency, but the truth is that things happen. Your car might break down, your air conditioner might unexpectedly break down in the middle of the hot Philly summer, or you may be involved in an accident that results in costly medical bills.

For that reason, the best time to prepare for an emergency is before it even happens. While you might not know what could happen down the road, being prepared will help you to stay financially stable no matter what comes your way.

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