Saving extra money for an emergency has always been important. In a pandemic that is unraveling the economy, emergency savings is even more critical.
“Now, more than ever, it is essential to have a sufficient amount of money to get through unexpected periods of income reduction or job loss,” says Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C.-based non-profit organization.
If you haven’t built up a back-up fund and are still earning a paycheck, here’s what you need to know.
The ideal amount of money to save
By funding an emergency account, it’s less likely you will need to take on debt if you lose a job or have an unexpected expense, such as needing to repair your car or pay for a medical bill.
Financial experts have long recommended a goal of having three to six months of expenses in your savings account. Saving more than six months of expenses can come in handy, especially if you work in an industry that is seasonal or relies on tips, commissions or bonuses as part of your overall salary.
“How much you save largely depends on your employment situation,” says Daren Blonski, managing principal of Sonoma Wealth Advisors in California. “If you work for an organization that is less likely to be financially stressed during these financial circumstances, three to six months might make sense. If you’re able to save more, having a larger emergency fund won’t hurt anything.”
In reality, it’s been an elusive goal for Americans for years. Now, growing your emergency savings is much more difficult with jobs vanishing across the country.
“Just getting to the point of having six months of expenses in emergency savings is a threshold fewer than one-in-five households had reached as of mid 2019,” says Greg McBride, CFA, Bankrate chief financial analyst. “Particularly for sole breadwinners and business owners, having more would be great but the widespread job losses and income disruptions in recent months have begun to erode or wiped out entirely what savings many had worked years to accumulate.”
If you’re still earning a paycheck and not in a serious bind, there are steps you can take to build your emergency fund.
Develop a savings rhythm
Creating a routine of saving on a regular basis increases the odds that you will save more money long term.
“Successful saving is all about the habit,” McBride says. “Establishing that habit begins with setting up a direct deposit from your paycheck or an automatic transfer from your checking account into a dedicated savings account.”
Park your money in a high-yield account
Keep your emergency savings in liquid savings accounts or money market accounts that generate higher interest rates.
“Your emergency savings should have as little risk as possible with it,” Sonoma Wealth Advisors’ Blonski says. “It’s recommended that you keep your emergency fund in a FDIC-insured institution and regardless of the poor interest rates at the bank, keep it in a place that is both accessible and liquid with very little risk.”
Trim expenses
To reach your goal, you will face tradeoffs that depend on your personal circumstances. With stay-at-home orders still largely in place, you probably are spending less on discretionary items, like entertainment and shopping. But you may want to trim other expenses, too, such as cutting out a subscription service you don’t use. Move the money you would have previously spent into your savings account.
Automate your savings decisions
Some financial institutions, such as Ally Bank, let customers create digital envelopes to make it easier for them to save for different purposes, such as for emergency savings or holiday shopping. Money can be automatically sent to those “buckets” from a paycheck. At Ally, the tool analyzes your checking account for safe-to-save money, then transfers it to your savings on your behalf.
While the bank launched the new tools in February, the early results are promising. Emily Shallal, senior director of consumer strategy and innovation at Ally Financial, says people who signed up for the tool have increased their savings by about five times.
“Everyone can benefit by changing their savings behavior through automation,” Shallal says. “This ‘set it and forget it’ strategy can really pay off in a short period of time. For those who can’t automate it, look for tools that will do it for you.”
Bottom line
By building your backup savings, you’ll have the flexibility to continue paying bills and buying groceries if you lose your income.
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