An emergency savings account is of the utmost importance. If you are a homeowner, there are a number of unexpected expenses that could occur, such as needing to replace your furnace or roof. Even if you are not a homeowner, you may need a new car or face unexpected medical expenses. Everyone needs to face the unpleasant reality that you may lose your job or face an illness which may keep you from working for months.
How much do you need in your emergency savings? It depends on your lifestyle, monthly expenses, income and dependents. You will want to track your actual spending for a month to get a realistic picture of your expenses.
If you are unsure of how to create a budget, start with the 50/30/20 rule. Half of your income will go to fixed monthly expenses. These are bills you cannot control, such as your mortgage or rent, car payment and insurance, Internet and utilities. Next, 30% of your income should go to discretionary expenses, which are expenses you control–such as food, new purchases and gifts.
The final 20% should go toward your various savings accounts, which include not only an emergency fund but also your retirement, kids’ college fund and vacation savings. If you do not have an emergency savings account, most of your 20% should go toward creating one.
Financial expert Dave Ramsey takes a slightly different approach to budgeting and says you should divide up your income as follows:
- Housing: 25% – 35%
- Transportation: 10% – 15%
- Saving: 10% –15%
- Charitable Giving: 10-15%
- Food: 5% – 15%
- Utilities: 5% – 10%
- Medical/Health: 5% – 10%
- Clothing: 2% – 7%
How much should I save?
Whichever approach you take, once you have a budget, strive to save three to six months worth of these expenses. For example, if your monthly expenses are $3,000, you should save between $9,000 and $18,000. Personal finance expert Suze Orman recommends saving eight months worth of expenses, as that is the average time it takes for someone to find a job. With the example above, Orman would recommended saving $24,000.
Saving so much can seem a bit intimidating at first, but keep in mind you can start small by saving a little each week. You may also want to take a second look at the budget you created to see if there are any discretionary expenses you can cut so you can transfer more money into a savings account instead.
Where do I save my funds?
Once you have created a plan for saving, you need to choose an account. The best option is an interest-bearing savings account or money market account where you can withdraw the money quickly and without penalty in case of an emergency. Different banks offer different interest rates, so it is a good idea to shop around for the best deal.
Stocks, mutual funds or other types of assets are not ideal places for emergency savings accounts, as they may lose value or you may be penalized if you need to withdraw funds quickly.
Your emergency savings account should be kept separate from vacation or retirement savings. In fact, one of the most compelling reasons for an emergency savings account is that you will not have to dip into your retirement or cancel travel plans if you face an unexpected expense. Your emergency savings account should be used as a safety net only.
Finally, if you do need to withdraw money from your emergency account, make sure you replenish the funds as quickly as possible. Unfortunately, most of us are not limited to one emergency in a lifetime, so it is best to always keep this savings account funded.