U.S. families rank saving for emergencies as the second most important reason to save, according to The Federal Reserve Board’s most recent Survey of Consumer Finances. Yet its estimate of the rate of saving by U.S. households indicates a significant drop in recent years, both in levels and as a percentage of disposable income.
Few Americans set aside enough to weather even a mild financial storm. According to a 2004 poll by the American Payroll Association, 68 percent of Americans think they would fall behind on their mortgage, rent or other bills if even a single paycheck were to be delayed.
Don’t be caught off guard. Use the following tips to prepare for occasional financial setbacks by setting up a rainy day fund.
How much to saveA standard rule of thumb for emergency funds is to set aside three to six months’ salary. If your income is irregular, it’s wise to save a little more. Estimate the number of months you could be out of work and multiply it by your standard monthly expenses. These should include things such as rent or mortgage payments, utilities, car or transportation expenses, grocery bills and insurance costs. It should also be enough to cover any deductibles on your car or health insurance.
How to get thereOne of the easiest ways to save is to have your bank set up an automatic withdrawal plan whereby a fixed percentage of your paycheck is transferred regularly to an investment account. A good amount to try to save each month is about a twelfth of your income (a little more than eight percent). This will enable you to save at least one month’s income every year. You can also increase your savings with any unexpected income you receive such as gift money, employment bonuses or inheritance funds.
Keep it accessibleBe sure to invest your emergency fund in a way that enables you to have access to it should the need arise. Your best bets are either a savings account with a bank or credit union or a money-market mutual fund. Savings accounts are insured by the Federal Deposit Insurance Corporation for up to $250,000, but typically pay only a low rate of interest. Money-market mutual funds aren’t insured but they provide a higher return. And they seldom drop in value as they invest only in short-term debt such as commercial loans, CDs and Government Securities. Be sure to talk with a financial planner about your situation before you invest.
Remember to reviewOnce you’ve established a rainy day fund, remember to review it periodically. Such things as the purchase of a new home, or the birth of a child, may cause your income need to increase. Be sure to keep yourself protected by adding money accordingly. With careful planning, you shouldn’t have to worry about paying for emergency expenses.