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Tips to Build and Maintain an Emergency Fund

Unless you have an unlimited amount of money, it’s in your best interest to be mindful of the difference between “needs” and “wants,” so you can make better spending choices. Needs are things you have to have in order to survive: food, shelter, healthcare, transportation, a reasonable amount of clothing (many people include savings as a need, whether that’s a set 10% of their income or whatever they can afford to set aside each month). Conversely, wants are things you would like to have but don’t require for survival.

It can be challenging to accurately label expenses as either needs or wants, and for many the line gets blurred between the two. When this happens, it can be easy to rationalize away an unnecessary or extravagant purchase by calling it a need. A car is a good example. You need a car to get to work and take the kids to school. You want the luxury edition SUV that costs twice as much as a more practical car (and costs you more in gas). You could try and call the SUV a “need” because you do, in fact, need a car, but it’s still a want. Any difference in price between a more economical vehicle and the luxury SUV is money that you didn’t have to spend.

Your needs should get top priority in your personal budget. Only after your needs have been met should you allocate any discretionary income toward wants. And again, if you do have money left over each week or each month after paying for the things you really need, you don’t have to spend it all.

Start Saving Early, It’s often said that it’s never too late to start saving for retirement. That may be true (technically), but the sooner you start, the better off you’ll likely be during your retirement years. This is because of the power of compounding—what Albert Einstein called the “eighth wonder of the world.”

Compounding involves the reinvestment of earnings, and it is most successful over time. The longer earnings are reinvested, the greater the value of the investment, and the larger the earnings will (hypothetically) be.

To illustrate the importance of starting early, assume you want to save $1,000,000 by the time you turn 60. If you start saving when you are 20 years old, you would have to contribute $655.30 a month—a total of $314,544 over 40 years—to be a millionaire by the time you hit 60. If you waited until you were 40, your monthly contribution would bump up to $2,432.89—a total of $583,894 over 20 years. Wait until 50 and you’d have to come up with $6,439.88 each month —equal to $772,786 over the 10 years. (These figures are based on an investment rate of 5% and no initial investment. Please keep in mind that they are for illustrative purposes only and do not take into consideration actual returns, taxes, or other factors).

The sooner you start, the easier it is to reach your long-term financial goals. You will need to save less each month, and contribute less overall, to reach the same goal in the future.

Having a stash of cash available in case of financial emergencies is crucial to good financial planning.

An emergency fund is just what the name implies: money that has been set aside for emergency purposes. The fund is intended to help you pay for things that wouldn’t normally be included in your personal budget: unexpected expenses such as car repairs or an emergency trip to the dentist. It can also help you pay your regular expenses if your income is interrupted; for example, if an illness or injury prevents you from working or if you lose your job.

Although the traditional guideline is to save three to six months’ worth of living expenses in an emergency fund, the unfortunate reality is that this amount would fall short of what many people would need to cover a big expense or weather a loss in income. In today’s uncertain economic environment, most people should aim for saving at least six months’ worth of living expenses—more if possible. Putting this as a regular expense item in your personal budget is the best way to ensure that you are saving for emergencies and not spending that money frivolously.

Keep in mind that establishing an emergency backup is an ongoing mission. Odds are that as soon as it is funded, you will need it for something. Instead of being dejected about this, be glad that you were financially prepared and start the process of building the fund again.