Budgeting can help keep you out of financial holes and help ensure your money is spent in ways worthwhile to you.
Save for a Rainy Day: The Importance of Emergency Funds
Unless you possess a superhuman ability to predict the future, unexpected financial expenses will pop up.
That’s why it’s important to have money set aside in an emergency fund.
“No matter how well you budget, life will throw curveballs at you,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “The furnace will break, or you will need to travel to an unexpected funeral or you may even lose your job. No matter what form it takes, it’s important to plan for these types of scenarios.”
Unfortunately, many Americans have meager to no emergency savings. According to a May 2016 report by the Federal Reserve, 46% of Americans said they would struggle to pay for a $400 unexpected event without borrowing or selling something they owned.
No Emergency Fund? Expect Trouble
If an unexpected cost arises and you are among those 46% of Americans, you could find yourself in a heap of debt.
You may be tempted to pay off unexpected expenses with credit cards, but that comes with a cost. According to financial comparison site Bankrate.com, the average credit card APR has, in recent months, hovered around 11% for fixed-interest cards and 16% for variable-interest cards. Loading up on credit card debt may also have negative consequences for your credit score, a vital component of your financial health.
Other people end up borrowing or withdrawing money from tax-advantaged accounts such as an IRA or 529. If you go that route, prepare to pay taxes on that money and get hit with additional financial penalties, depending on the account.
“We realize that for some people, it may be hard to create an emergency fund,” Correnti said. “Bottom line: if at all possible, build up that fund so you can avoid more drastic financial measures. You’ll be glad you did.”
Emergencies Only, Please
The fund should be used for unexpected emergencies, such as if you lose your job or if your car unexpectedly breaks down.
“Your dream vacation to Europe and that big-screen TV are not emergencies,” Correnti said. “Money for those types of expenses should be placed elsewhere."
There are also costs that everyone should anticipate even though the timing isn’t certain – such as health care. Although an emergency fund can help with surprise medical bills, you may want to consider setting up a Health Savings Account (HSA) – if you’re eligible – to defray some of these costs in the future.
How Much Savings Should I Have?
Financial experts provide divergent advice on the size of your emergency account. Some recommend having $1,000 on hand, while others recommend holding as much as a year’s worth of expenses.
The truth is, each person’s personal and financial circumstances are different, so it’s hard to give cookie-cutter advice. That said, certain people may be more vulnerable to unexpected expenses and may want to plan accordingly.
“Some people’s jobs are less secure than others and some people drive cars that are more prone to breaking down,” Correnti said. “It’s important to assess your financial situation to get an idea of how much money to set aside.”
Appropriately-sized emergency funds can take a while to build. A good strategy is to set aside a certain amount each month and deposit that money into the emergency fund.
Where to Save Your Money
Money for emergency funds should be placed somewhere low-risk where the money can be easily accessed in a time of need. Consider putting your emergency money in a checking, savings or money market account. “Whatever you do, keep emergency money out of the stock market,” Correnti said. “Unexpected costs don’t just occur in bull markets.”
The content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.
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