You’re undoubtedly familiar with the traditional advice on maintaining an emergency fund. As David Jones, president of the Association of Independent Consumer Credit Counseling Agencies explained in Bankrate, the fund should comprise six months’ equivalent of take-home pay in savings.
Why So Much?
If you’ve never kept an emergency fund before, saving the equivalent of six months take-home pay may sound like an insurmountable goal. But consider the seven life surprises requiring an emergency fund described by U.S. News and World Report. Among these are job layoff, vehicle expenses, medical emergencies, and major household repairs. Sound familiar?
What if you’re laid off? The average job search consumes more than nine months, according to J.T. O’Donnell, chief executive officer of Career Realism. Even if you can pick up a little part-time or underpaid full-time work, where are you going to be without that emergency fund to bridge the gap?
The average car repair costs $392. 49, Car MD says. A lot of good that does you if your car is the one that needs the $5,474 transmission assembly replacement and electronic control module reprogramming repair, or the $1,154 catalytic converter replacement, or hybrid inverter assembly replacement for $2800. According to How Stuff Works, the average American household spends $5,477 per year on automotive expenses. That breaks down into $2,208 for gas and $3,269 for repairs and maintenance. In monthly terms, gas, maintenance, and repair expense is similar to the cost of a second car payment.
Banking My Way estimates annual maintenance and repair costs on a home at one percent of a home’s value. That’s daunting enough, but there’s going to come that time when you need a new roof or heating system and blow more than the year’s budget a single project.
What about medical expense? Even if you have health insurance, the average out-of-pocket cost for uninsured expenses is expected to reach $3,301 per household in 2014, not including insurance premiums, according to U.S. government projections. Throw in a couple of emergencies and there’s no telling how much higher than average the bill might go.
Building an Emergency Fund
Before you throw up your hands and announce six months take-home is impossible, consider whether you can afford not to build and maintain an emergency fund.
Forty-four percent of American households lack sufficient emergency savings to cover three months’ needs, according to the Assets and Opportunity Scorecard published by the Corporation for Enterprise Development. Twenty-seven percent lack savings altogether, CNN said. Without a cushion, choices in an emergency might include such unsound financial practices as taking out payday loans, overloading credit cards, or skipping work for lack of means to get there, MSN Money’s Quin Street notes. His advice to folks without emergency savings is “wake up and smell reality.” Giving up unnecessary expenses from fast food to manicures is one approach to finding savings, while coming up with extra money by taking on extra work is an alternate approach. Street also recommends going generic, using coupons, and selling used household items.
Mint Life suggests making a list with a realistic separation of wants from needs. Smartphone? Cable television? Restaurant meals? Once an expense is designated non-essential, rate it in terms of its emotional desirability. Keeping the top couple non-essentials while ditching most of the rest is a way to build savings.
Instead of letting yourself feel angst about extras you’re giving up, focus on the increased emotional comfort you’ll gain as your emergency fund grows and you know a sudden expense will no longer send you reeling.