The recent federal government shutdown showed how unprepared many Americans are to face a financial emergency. Financial security expert Pamela Yellen, a two-time New York Times best-selling author, provides a guide on building your emergency fund.
The longest U.S. government shutdown in history laid bare an uncomfortable truth: Americans aren’t saving enough and the majority of us have no emergency fund to protect us when a financial crunch strikes, Pamela says. More than 70 percent of all types of employees at all income levels live paycheck to paycheck and said they’d have difficulty meeting their financial obligations if their paycheck were delayed for just one week, a recent survey finds.
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“This explains why, after missing just one or two paychecks, we heard so many heart-breaking stories from government workers who weren't being paid or were furloughed,” Pamela says.
Emergencies don’t come with warnings. Sooner or later we all face the unexpected, whether it’s a job layoff or cutback or surprise expenses from a medical emergency, home repair, or tax bill. To prepare, Pamela recommends people build a safe and liquid rainy day fund equal to at least one year of household income, and shares a 4-step plan to do it:
- Audit your credit card and checking account statements for the last three months to weed out charges for services you rarely use or don’t need.
- Get clear on the difference between “wants” and “needs” – and put the brakes on impulse buying. One way to do this: wait at least 24 hours before buying anything that is not a necessity, and at least seven days before making any large purchase. Another is to try paying with cash for one month (studies show you'll spend 20 percent less on average).
- Take a hard look at your daily habits. Grabbing lunch at a fast food or other restaurant adds up. So does buying that $5 (plus tip) Starbucks coffee every day. Have trouble letting go of such expenses? Consider the reasons you need a healthy rainy day fund. “If you don’t have a sizeable emergency fund, you can’t afford it,” Pamela says.
- Beware of "Parkinson's Law," which warns that "expenses rise to equal income," to avoid spending all the money you’ll be saving.
The good news is you can build a safe and liquid rainy day fund that doubles as a retirement savings plan. To do this, Pamela advocates a strategy she calls “Bank On Yourself” as the safest way to build and protect wealth in any economy.
“The key is to get started building your emergency fund today – before you need it,” she says.