The emergency fund is a critical tool for financial security — a fact that was reinforced for many when the coronavirus pandemic tested their ability to weather an economic storm.
The personal saving rate hit an all-time high last year as consumers hunkered down during the pandemic. Experts, however, say the full ramifications of 2020’s economic downturn on individuals’ abilities and willingness to save for an emergency are still unknown.
The portion of disposable income set aside as personal savings during the pandemic hit a high of 33.7% in April 2020, according to the U.S. Bureau of Economic Analysis. Though the personal saving rate dropped from there to the most recent rate available of 13.6% in February 2021, it’s still relatively high compared to pre-pandemic levels of 7.2% in December 2019.
An emergency fund, also known as a rainy day fund, can help individuals cover expenses in cases of job loss or other unanticipated events, as well as provide peace of mind. Most experts advise fully funding a savings account for emergencies before investing and, in some cases, before paying down debt.
[Read: 15 Creative Ways to Save Money.]
Though historical data shows in the years prior to the pandemic more people were saving and setting aside money in emergency funds, the quick uptick in saving in 2020 and 2021 may not be indicative of savings habits going forward.
“At the start of the pandemic, people were not spending and by default they were saving. That got dragged out as lockdown continued,” says Douglas A. Boneparth, financial advisor and president of Bone Fide Wealth in New York. “But, slowly but surely, people started to spend again and find new ways to spend,” he says, noting that consumer saving data may indicate delayed spending rather than an increased effort to save.
“There is a great deal of pent up demand around the things that got hurt the most, like going out to eat, traveling, hotels,” Boneparth says. “The pendulum swings both ways.”
Why Have an Emergency Fund?
Emergency savings are often seen as a key indicator of the financial well-being of families, demonstrating both a family’s ability to save and its level of financial literacy. Creating an emergency fund can also help families avoid debt and take advantage of other financial opportunities.
But many households today are living paycheck to paycheck with no savings should an emergency arise. A 2018 survey from the Financial Industry Regulatory Authority’s Investor Education Foundation found that 46% of individuals lacked an emergency fund to cover expenses for at least three months.
“In 2009, right after the Great Recession, it was pretty low — about 35% of families had emergency savings, and that increased steadily as the economy improved,” says Gary R. Mottola, research director at the FINRA Investor Education Foundation. Looking ahead, Mottola says given that many people suffered a job loss or emergency event in 2020, “experience may influence people’s behavior, and in addition, there are the economic factors of lower employment rates and stimulus payments,” all of which may affect saving trends.
How Much to Save in an Emergency Fund
The target amount to save varies depending on an individual’s expenses and risks. Most financial experts advise individuals to save enough to cover three to six months of expenses in an emergency fund.
The pandemic may have pushed some to beef up their liquidity amid all the uncertainty of 2020, but on the other end of the spectrum, for low-income households, recent FINRA research indicates that even a small emergency savings of $100 or $250 can be meaningful in a family’s financial stability.
Typically, emergency funds should be held in a savings or money market account. In some situations, using a home equity line of credit on an existing property or tapping retirement savings may be an option as an alternative to a traditional emergency fund.
When to Spend an Emergency Fund
It may be wise to lean on the conservative side with what constitutes an emergency worthy of dipping into these funds, says Ben Carlson, a chartered financial analyst at Ritholtz Wealth Management and author of the A Wealth of Common Sense blog.
“A lot of it depends on how people define an emergency,” Carlson says. “They have this bucket of savings that they use whenever something variable comes up, like a car breaking down or a house needing to be fixed. A lot of those infrequent expenses happen on a variable basis, so you can’t really count those as an emergency — that’s just part of your budget you have to think about.”
Instead, he suggests individuals aim to spend emergency funds in cases such as an unexpected illness or job loss.
Budgeting and Starting Small
Those without the standard three to six months of expenses saved up should start small, set a realistic goal and adjust their account settings to automatically move the designated amount monthly into a savings account, Carlson says. Budgeting and tracking expenses can help create positive financial habits that allow room for saving.
“Start slowly and be realistic that it’s going to be hard to get up to the level people want you to get,” he says. “Just get started and get the ball rolling. Even if it’s $25 a month, as you get used to spending and budgeting and get in the habit, you can increase that. Make it easy to do, and automate a lot of that to take the decision out of your hands, so that you never even notice it’s happening.”
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Be Ready for the Unexpected With an Emergency Fund originally appeared on usnews.com