It doesn’t take a rocket scientist to calculate your reserve fund target. However, you have to understand that importance of knowing the right amount to save up for. The consequences of having the right amount in this fund could make you lose a lot of financial opportunities.
According to a study released by PewTrusts.org late last year, 3 out of 4 Americans plan to use the money they have in their checking or savings account when they are faced with an emergency expense. While this is a general sentiment, a lot of American households do not have enough liquid savings to pay for one month’s worth of expenses. Not only that, the majority does not even have enough assets to cover 6 months worth of expenses. As much as we know that emergency funds are important, a lot of us are lacking when it comes to the actual cash that we can pull out when that unexpected event happens.
This bit of data shows that a lot of us have a lot of work to do when it comes to building our emergency funds. Of course, this leads us to ask the question baffling most consumers: how much reserve fund target should you be saving up for these emergency situations? It is not a question that you should consider lightly.
An emergency fund that is too small will not really be of help when you are faced with an unexpected situation. One of the common causes of credit card debt is the lack of sufficient emergency funds. When the situation calls for some cash and you do not have it, our tendency is to use our credit cards to get out of a tight spot. We all know that being emotional (which is usually a common state in an emergency) puts us at a disadvantage when making financial decisions. You might end up charging too much on your credit card and that can lead you to incur a lot of debts.
On the other hand, having too much money in your emergency fund is also scary. You might be wasting a lot of financial opportunities if you put in too much money in your reserve fund.
2 tips when computing your emergency fund target
When calculating your reserve fund target, you should not only avoid having “too little” on your account. It is also important for you to avoid having “too much” funds.
Some experts might go as far as to say that having too much on your reserve fund could compromise your road to financial abundance. According to an article published o Investopedia.com, instead of working on saving in an account that pays you 0%, you need to think about putting it somewhere it can grow your financial net worth. At the very least, you want to put it somewhere that can eliminate the areas that are sucking the money out of your net worth. For instance, debt is one area that takes away money from you – especially those that with a high-interest rate.
Obviously, we need to find a balance. It is too reckless to live without an emergency fund but it is also a waste if you put too much into it. The key is to know the right reserve fund target so you can keep your finances secure without compromising the growth of your finances.
Here are two smart tips that you can use to approach this problem.
Know how much you can realistically live on each month.
It is not enough that you get the sum of what you are spending. You need to think about the expenses that you will include in this sum. For instance, we do not suggest that you focus on the bare necessities in your spending plan. Most of the time, this does not include entertainment expenses. That could end up being frustrating in the long run. Think about the important expenses but continue to include even those that you know you can live without. That way, when you are forced to live on a 3-months worth of emergency fund, it is possible for you to stretch it for up to 6 months.
Consider all your sources of income.
One of the reasons why we set a reserve fund target is to prepare for unemployment. When you lose your day job, your cash flow will be compromised. This is when your emergency fund will come in handy. That being said, it is important for you to consider all your sources of income when you are computing for your emergency fund target. If you have successfully opened several sources of income, you might not need to save a high amount on your reserve fund.
Calculate the number of months you want to be supported by an emergency fund.
This is usually the final step in calculating how much you need to save for the unexpected expenses. How many months should you be saving? The best way to base it on is the average duration of unemployment in the country. According to the data published by the Bureau of Labor Statistics on BLS.gov, 4 out of 10 unemployed Americans are unemployed for more than 15 weeks. That is almost 4 months. It should be safe to assume that if you lost your job, you will need 4 months worth of expenses. But then again, if you have other sources of income, you can probably scale this down to 3 months.
Think about these tips when calculating your reserve fund target. It will really help you keep this fund at a reasonable level – not too little and not too big either.
What to do with the excess money from your savings?
Even if you reached your emergency fund target, it is still a good idea to keep on saving money. There are so many ways that saving can improve your personal finances. If not towards your emergency funds, here are the different areas that can benefit from your savings.
Your debts.
This is one of the areas in your financial life that can waste a lot of your money. If you have a lot of high-interest debts, you should focus on paying them down aggressively. When you have paid off debts, you can watch your net worth increase significantly.
Your retirement fund.
Saving for your future is never a bad thing – as long as you put it in a place where it can earn you compound interest. If you have the extra money anyway, you should think about maximizing your retirement savings. That way, you can enjoy a comfortable retirement.
Your income.
The final way that you can use your extra savings is by using it to capitalize on a passive income. Earning extra income is always a great way to increase your net worth. But beyond that, diversifying your source of income will help you secure your finances. If you set it up right, this might even pave the way for you to retire early.
There are so many goals to work on after you have reached your reserve fund target. All of these can help you grow your personal net worth so you do not have to compromise your future by borrowing too much debt. An emergency situation can be a scary event but that does not mean you cannot prepare for it. People say that the unexpected will happen – let us make sure you are prepared for it.
