Only 39% of American’s are prepared to cover a $1,000 emergency expense. This is an unfortunate statistic that the Covid pandemic has uncovered. Without emergency savings, many are left vulnerable when inevitable surprises pop up along the way.
I first read this stat and the first thing that popped into my head was poverty – too many people living at or under the threshold and unable to shave off money each month to set aside in case the car breaks down or a tooth is chipped.
The predicted federal poverty rate for 2021 is 13.7%. Let’s leave aside that this is unforgivable in the richest country in the world. That leaves 47.3% of Americans with the potential to plan for an emergency, armed with the right knowledge.
Why build an emergency savings fund?
This might seem like a silly question – we all know that it’s important to expect the unexpected. However, the real danger of not being able to cover an emergency is in the fees that trap people in debt spirals.
Non-payment is generally met with further fees, or maybe you pay with a credit card, personal loan, or you overdraft your checking. You’ll be hit with high-interest rates or fees that pile up while you find ways to pay that money back.
I’ve also heard these funds called “oh shit funds”. There’s a difference between saving enough to catch you when you’re surprised by your vet bill and saving enough to prepare for losing your job. The latter is much more expensive.
How much is a an Emergency Fund?
This depends on your lifestyle, the more lavish, the more you’ll need. However, for us average Joe’s, $1,000 should be enough to catch us when the brakes or furnace goes.
Keep in mind that how much is in an emergency fund will depend on the size of emergencies your lifestyle lends itself to. Homeowners, for example, can have much more costly emergencies and will need more saved.
I’ve read some blogs that suggest finding ways to save $1,000 this month. That seems a bit aggressive. I suggest spreading that $1,000 saving over the course of a year. If you can save more, awesome! However, if you’re just starting your money journey, go easy. Setting realistic goals is important to success.
That’s $83.33 dollars per month, $41.67 per paycheck or $19.23 per week
I believe for many of us, those numbers are achievable, but you have to trick your brain into saving.
Learn more about setting and maintaining a budget here
Why saving is so hard
We humans hate to let go of something we already have. In fact the pain of losing something is twice as powerful as the motivation to gain something. This is called loss aversion.
These are the dynamics at work that may have held you back from building emergency savings, despite knowing you need it. Once money is in your account you don’t want to see it “go away”. The motivation for the gain of an emergency fund is not as strong as the pull to keep that money available to you.
When I originally tried saving for an emergency fund I opened up a savings account, linked it to my checking account, and started slowly moving funds into it.
The problem was the money was still available to me. I would check my bank account, there were those dollars I had moved over. Over and over I just transferred them right back into my checking account and found ways to use them up.
Averting Loss Aversion
The only thing that I have found to work is to automate my savings. Ideally these automated savings go into accounts that are tough to access. Many people choose to open up a money market account. Technically these accounts are supposed to be “high yield” because your money will be invested.
However, the standard rate of inflation is 2% and most of the yields right now are under 0.5%. So you lose 1.5% in value over a year.
Money markets are not my favorite tactic. I chose to start saving with Acorns. I love the simplicity of the app, the extra bonuses of round-ups moving into my account, and the partnerships the company has built where I can earn money back on things I would buy anyway.
Other investment apps that have earned some popularity and allow you to auto-deposit are Stash and Betterment.
A note of caution
Watch your fees. Acorns is $1 per month so you could start to see your money whittle away. This is also why this is not an app for the long term. You can think of it as a boost to get you started that allows you to work around the powerful force of loss aversion.
It also takes longer to pull cash out of these accounts. You should be prepared to wait 3-5 business days to see the money hit your checking account.
Certainly, some would advise against an investment app for building your emergency fund because of the two points above. In the end, it comes down to what works for you. That’s finding the best approach to making sure you’re covered when the unexpected occurs.
Life is always going to bring unexpected expenses our way. However, we don’t need to be completely de-railed financially in these moments. You can build an emergency fund just by saving $19.23 per week using a strategy to avoid loss aversion.
I want to know how you’re planning your emergency safety net! Post below to share with me and the rest of Olive the Money’s readers.