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Tips for Establishing an Emergency Fund

Paying major expenses

When emergency needs arise, the last thing people want to think about is how they will keep the household running and pay for corrective actions they may need to take if they’re temporarily out of commission. Unfortunately, emergencies may come with expensive bills that can be troublesome to deal with financially.

Unexpected health issues, job loss, divorce, car accidents and natural disasters are some of the top drivers of emergency needs. While using a credit card or personal loan are quick ways to obtain funds to pay for such situations, it’s wise to establish an emergency fund to avoid interest payments. Emergencies are not fun to think about and you certainly cannot predict them, but you can plan ahead financially for whatever might happen.

Set up an emergency fund

It’s recommended to have three to six months of expenses (not income) with ready availability. This is money you can use to cover your costs of living while you are getting back to your normal situation.

Use these tips for setting up and managing an emergency fund.

  • Calculate your monthly living expenses. Include required monthly items, such as mortgage or rent, utilities, food and outstanding credit payments, but not discretionary items including vacation, entertainment, dining out and new clothes.
  • Budget for your emergency fund. Start saving some amount every week. “Pay yourself” along with your other obligations and creditors. Using direct deposit from your paycheck can be a helpful option to be sure it really happens. Give up some luxury items, at least in the short term, for faster savings.
  • Save rather than splurge. If you have money from a tax refund, job bonus, part-time job or other extra income, put it toward your emergency fund. Don’t splurge until you’ve met your fund target (along with other goals such as paying off credit card debt).
  • Don’t treat every event like an emergency. Plan ahead for predictable one-time items such as year-end taxes, car insurance, back-to-school shopping and vacations so they are not emergencies. Use your emergency fund for truly unexpected situations.
  • Deposit the money in a separate fund. It’s tempting to “borrow” money from your emergency fund if it’s easy to get to. Keep the account separate and don’t access it except to make deposits.
  • Keep a small amount in cash. If your emergency might limit your ability to get money from your account via a bank or ATM, having something on hand to tide you over for a few days can be quite valuable.
  • Put your money in an interest-bearing account. While you want a small amount of cash on hand, don’t keep your entire emergency fund in your mattress or a lockbox. Money stashed in your home is not covered for theft or other loss, while money in a financial institution is secure.
  • Reset and start over again. If you do withdraw from your emergency fund, replenish it as quickly as possible. Since you’ve already done it once, the second time might be easier.

While there are always other options like credit cards, personal loans and home equity loans, an emergency fund allows you to avoid potential interest payments. The emergency situation may never come, but you’ll be glad to have the cash available if it unfortunately does.

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