Why you MUST save an emergency fund
At times, you may need a back-up plan if something goes wrong, especially if something unexpected is impacting your financial situation.
To be sure, it would be wise to build up an emergency fund.
This emergency money is designed to help you cover any potential financial problems you may see in the short or long term.
You hope you never need it, but an emergency fund could save you if you lose your job, suffer a death in the family, have a medical emergency, or face other major expenses that your insurance might not cover. .
Below we explain how to save and how much money you might need.
How to save money
First, you’ll want to analyze all of your daily and monthly expenses.
Personal finance expert Dave Ramsey has broken down the percentages your take home pay should be allocated to.
He recommends that 25% of your budget be spent on housing costs, 10-25% for insurance, 10-15% for food while saving 10%.
Then you should look at the options where you can store the money for an emergency fund.
One place you might turn to is a high yield savings account, which is recommended by many financial experts.
Compared to traditional savings accounts, high yield savings accounts entice you with a higher interest rate.
Specifically, a high yield can earn 20 to 25 more in interest rate compared to a traditional savings account.
And according to Gordon Achtermann, a certified financial planner based in Virginia, “there is no risk of loss of capital” because funds up to $ 250,000 are insured by the Federal Deposit Insurance Corp.
However, a high yield savings account is viewed more as a short-term plan to store money, which means you shouldn’t expect to become a billionaire in two years.
If you are looking for a bigger rise, you can try investing it in index funds and mutual funds.
Just make sure you don’t invest it all, as you’ll need easy access to cash if you suddenly have an emergency.
While investing in funds is often considered less risky than traditional stocks, they are also never guaranteed to produce returns.
In fact, you could lose money if you put it in the wrong funds or if the stock market collapses.
Justin Green, financial planner and founder of Assist FP, warns against investing emergency funds because “the goal is not growth”.
“Some index funds were down 25 +% last March and you don’t want to have volatility in your emergency fund,” Green told The Sun.
He adds that it is “to have access to stable and liquid funds in case of emergency”.
How much money do you need?
Once you have decided where to put your money in an emergency, you will need to calculate how much you need.
Many experts recommend that you have enough to cover up to six months of expenses.
For example, assuming the monthly expenses cost you $ 4,000, you might need to save up to $ 24,000.
If you follow Ramsey’s model and save 10% of your income, that means you would have up to $ 400 per month to put into your emergency fund.
Suppose you chose a high yield savings account and immediately deposited $ 4,000 in it and added $ 400 to it each month at an annual interest rate of 0.50%.
After four years, it would be worth $ 23,478.07 according to The NerdWallet Savings Calculator.
Don’t ruin your retirement
The only problem with contributing to an emergency fund is that you may not be saving enough for retirement.
John Li, co-founder and chief technology officer of financial lending firm Fig Loans, told The Sun you’ll want to avoid taking your retirement money “at all costs.”
But he suggests that taking out a loan might not be the worst idea if you don’t have enough to prepare for an emergency.
“If you have a low interest rate on a line of credit, it’s better to borrow for the short term than to risk your financial future,” Li said.
He added that “you will pay less interest than you would in withdrawal penalties.”
Another thing that you can try to avoid undercontributing in your retirement is to reduce your spending in certain areas.
For example, Ramsey’s strategy suggests allocating 15-20% of your income to personal expenses and charity.
Maybe you can find a way to reduce that number by 5-8% for a few years so that you can build up enough money for an emergency fund and contribute enough for retirement.
We recently broke down four Social Security surprises that can ruin your retirement if you’re ready.
And we show you how to become a Roth IRA millionaire at 65.
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