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You might be surprised at how little financial shock the average American could handle.
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The average American’s emergency fund is nowhere close to where it needs to be. Half of Americans have less than $500 in emergency savings, according to data from Prudential. If an unexpected expense came up that was greater than $500, half of Americans would need to borrow the money or sell something to pay for it.
$500 — or even $1,000 — isn’t nearly enough to be truly prepared for tough financial times. Here’s why an emergency fund is so important, how much you should have set aside, and what to do if you aren’t well-prepared for unexpected expenses.
Why an emergency fund is so important
Let’s face it — life happens. Your car can get a flat tire, your child might need an unexpected visit to urgent care, or you might need emergency dental work, just to name a few possibilities. And far too few people plan for the unexpected.
An emergency fund is critically important because it allows you to deal with the unexpected without derailing the progress you’ve made elsewhere in your financial life, or worse, without digging a financial hole by borrowing money. You’ve probably read that long-term investing is the best way to build wealth, but it’s hard to do that if you have to dip into your brokerage account every time an unplanned expense arises. And if you need to charge every unplanned expense to a credit card, you’re setting yourself up for a cycle of debt that can be tough to overcome.
How much do you need?
The general rule of thumb among financial planners is that Americans should aim to have six months’ worth of expenses set aside in a readily available place, such as a savings account. So, to figure out your emergency fund target, add up all of your expenses for a month, including fixed expenses (housing, car payment, etc.) as well as realistic estimates of variable costs like utilities, gas, and groceries. Aim to have at least six times that amount so you have six months’ worth of savings. The idea is that your emergency fund should not just be enough to handle an unplanned expense, but should provide you with sufficient cushion if you lose your job or are otherwise unable to earn money. Bri from The School of Betty recommends figuring out what an emergency looks like to you to help with the savings process. “Defining this will not only help you from spending these funds on non-emergency things, but will also give you permission to use these savings when you actually need to.”
Now, six months’ worth of expenses can be a big number and might seem like an intimidating goal. But you don’t have to get there right away. Even a $1,000 emergency fund will put you in better shape than the majority of Americans and should be enough to handle most unexpected expenses. So, if a six-month emergency fund seems like a lot to aim for, set a goal you can realistically achieve in the next few months and go from there. Once you reach it, set another target, and so on. For full disclosure, it took me well into my 30s before I had a six-month cushion set aside.
Take steps to prepare yourself
If you need to build up your emergency fund, there are two steps that can make it much easier. First, open a separate bank account just for your emergency fund if you haven’t already. Keeping your emergency fund separate reduces the temptation to use it as everyday spending money.
Second, make it automatic. Figure out an amount you could comfortably afford to put into an emergency fund every time you get paid and set up a recurring transfer into your emergency account.
The bottom line is that most Americans are very underprepared for financial hard times, but with some solid planning, you don’t have to be. By taking steps to build your emergency fund, you’ll be on your way to a higher level of financial comfort faster than you might think.
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