While building a financial portfolio, you might include investments like real estate and stocks to provide for you and your family when you retire. However, emergencies can interrupt your savings plan and make it harder to meet your goals. To stay on track and cover your expenses during a crisis, you can create an emergency fund. Keep reading to find out about building and structuring this important financial tool.
What’s an Emergency Fund?
An emergency fund provides money to cover unexpected expenses. Here are some ways you might use an emergency fund:
- Covering health care increases or unexpected medical procedures.
- Supporting adult children or parents.
- Repairing your home after a storm.
- Replacing a vehicle.
- Paying expenses after a loss of employment.
- Replenishing savings after a market crash or other crisis.
In case of these events, you might already have insurance or other funds to help you, but these funds might not cover all of your expenses. For example, if you lose your job, you might receive a severance payment, but that payment might not be enough to cover your expenses if you don’t find another position quickly.
Why Are Emergency Funds Important?
Having money set aside for emergencies can ensure that you continue to meet your financial goals, even after experiencing a crisis. If you’re saving toward retirement, an unexpected expense can affect your ability to retire when you originally planned to. Covering emergency expenses from a special fund can also allow you to pursue business opportunities when they present themselves. For example, if you get a time-sensitive opportunity for a lucrative investment, it’s important that you can make that purchase without worrying about covering potential emergencies.
An emergency fund can also help you maintain a strong credit score. Without a readily available supply of cash, you might use credit to cover costs from an unexpected event, such as a job loss or an emergency surgery. Because of interest rates, using your credit to pay for emergencies costs you more in the long run and lowers your credit score, making you ineligible for optimal loan rates on future investments.
How To Build an Emergency Fund
Here’s how to build an emergency fund:
- Start with $1,000: The first part of the savings process is the hardest, so set yourself a reasonable goal of $1,000. At this point, you might simply keep your emergency fund in your regular savings account.
- Track your monthly expenses: Once you have $1,000 in savings, keep track of the money you spend over a few months to estimate your average monthly expenses. Include any fixed payments, such as a mortgage or car payment, along with fluctuating expenses like food and activities.
- Build a one-month fund: With the information you’ve gathered, choose a one-month fund goal on the high end of your average monthly expenses. This will build some extra money into your one-month fund for unexpected expenses.
- Grow your fund for three months: Many financial advisors recommend having at least three months’ worth of expenses in your emergency fund. After you’ve reached three months’ worth of money, you can begin structuring your fund to increase your wealth.
How To Structure Your Emergency Fund
As you increase the amount of money in your emergency fund, it might be helpful to create structure within the fund to get the most value from your money. Here are a few techniques you can use to add structure to your emergency fund:
Add a High-Yield Savings Account
While your bank might provide a savings account linked to your primary checking account, you can also open an additional savings account with a firm that offers higher interest rates. You can get high-yield savings accounts at some traditional banks, but online banks focus solely on high-yield savings accounts. Putting emergency fund money in one of these accounts makes it easily accessible and gives you the benefit of a high-yield interest rate.
Consider Laddered Certificates of Deposit
Most banks and financial institutions offer certificates of deposit (CDs), which are timed deposits with higher interest rates than traditional savings accounts. The trade-off for the higher interest rate is less liquidity because you’ll get a fee if you withdraw the cash before its maturation date. Once you’ve built a significant amount of money in your emergency fund, you might portion some of it into laddered CDs with different renewal dates or term lengths. You can use this money for long-term emergencies, like unemployment or sustained health issues.
Create Spending Rules
If your wealth supports your spouse or other family members, it’s important that everyone understands the purpose of emergency fund money. During the financial planning process, it’s helpful to meet with any dependents to discuss the emergency fund and set some ground rules about using the money, especially if other people have access to the savings account. Consider making a list of events that you would consider to be an emergency, such as layoffs, unexpected surgeries, or natural disasters. That way, you can avoid conflict when or if the time comes to use the emergency fund.
Develop an Emergency Response Strategy
It can be challenging to act strategically during an emergency, especially if you’re incapacitated. Consider drafting an emergency response strategy beforehand and giving a copy to whoever might make financial decisions in your place. An emergency response plan might describe which funds to use first or how to use certain funds. For example, you might prefer to use your primary savings first before spending any money in a high-yield savings account.
A qualified financial advisor can help you plan and build an emergency fund that meets your unique needs. At 3D Partners Wealth Advisors, we know that life can be complicated, so you need a financial plan that can handle any situation. Our Wealth Management Services can help you plan for your retirement while ensuring you’re prepared for emergencies. Contact us today to find out how we can make your money work for you.