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Creating Your Emergency Fund

Far too many Americans fail to properly save for emergency situations that leave them without an income. Creating an emergency fund is a difficult process that requires households to stick to a strict budget, but the security of an emergency fund makes the process worth the work. It should be noted that saving into an emergency fund is not the same as saving for a retirement fund, or a general savings account. This should be a completely seperate fund, used only in the case of legitimate emergencies.

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Why Create an Emergency Fund?

While you may feel that an emergency fund is a waste of money, it is possible for unexpected events to occur that seriously limit your ability to pay for your basic necessities. People who fail to plan ahead may even face foreclosure or serious damage to credit history when they are unable to pay for their mortgage, credit card bills and other obligations.

Job loss is one reason that you need to set up an emergency fund. Even jobs that seem relatively stable can result in loss of employment when the economy struggles. Many people are finding themselves without a job after working successfully for an employer. Key employees that add value to a company are still at risk of losing their job.

Injuries that occur at work or at home can lead a permanent condition that makes it impossible for you to work. While an emergency fund can help you pay for short-term financial needs that come up during your recovery, disabilities that make it impossible for you to work for a long period of time may require you to look into applying for social security disability insurance (SSDI) benefits. SSDI benefits are funded by paycheck deductions, so you pay into the insurance while you are working. more info about SSDI and similiar programs can be found here. Injuries are much more common than you might think – according to a Harvard University study, about half of bankruptices are connected to an illness or other medical expenses. While it may be tempting to assume it will never happen to you, ignoring the possibility could be disasterous.

Creating Your Fund

Creating a fund may be easier said than done. Families across the country are struggling to pay their bills, and finding money to set aside for a rainy day can be difficult. However, most families have a little bit left over if they examine their spending and shift their habits to be more favorable for saving. For example, do you stop at an expensive coffee shop like Starbucks each morning to fuel up for your day? Consider cutting out the fancy coffee for a home-brewed cup. The little extras like trips to the movie theater, dining out and premium household products can be pared down to save money.

Unnecessary insurance coverage is a big waste of money that millions of Americans are spending on each year. Credit card insurance, flood insurance and auto collision coverage are all types of policies that most people can do without. Also double check your health insurance for this like coverage on common maternity medical expenses. If you aren’t planning on having any (or any more) children, these can be safely dropped from your policy, freeing up some very useful cash.

Being proactive about saving may be the most difficult part of creating your emergency fund. Set up automatic deductions from your checking account to a designated savings account to make sticking money aside an effortless activity. If you wait to put money into savings after paying for everything else and using spending money, it’s very likely that you’ll end up with little left over. The mantra here is “pay yourself first.”

Another easy tip is to keep all of the change that you receive after making purchases, and treat $1 bills as change to make the savings process go faster. Spare change and $1 can really add up. This will also make you think twice about buying something that’s $3.00 with a $5 bill, as it effectively makes that coffee (or other small item) cost $5.00 instead.

Setting a Goal

How do you know when you’re done creating your emergency fund? A general guide is to save enough money to cover all of your necessities for three months. Examining your spending is a good time to also determine which bills will need to be paid if you find yourself facing a situation during which no income is coming in. Having an emergency fund with at least three months worth of expenses could make the difference between a difficult time and financial ruin. Start preparing now – your future self will thank you for it.

Shawn O’Reily is a tech obsessed financail advisor with Wells Fargo. You can read his blog at ShawnOReily.com or find him on Twitter.

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  • http://modestmoney.com Simon @ Modest Money

    I like how you are straightforward about the difficulty in creating an emergency fund. Its difficult, there are just so many things yearning for a piece of our income that we may think why bother with an emergency fund. I think though its crucial, it gives you peace of mind and a boldness that spurs you to take bold moves with your life because you have a cushion in case things go wrong. So as difficult as it is to save for an emergency fund, one ought to start, however small.
    Great post

  • Ankit Agarwal

    Thanks for your comment Simon! I couldn’t agree more, even though i am pretty young to think retirement but i still feel bad for not developing a discipline for money management earlier, would have helped me reduce the student loan burden to a great extent.

    PS: Love your blog, you have a new subscriber

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