In a recent report from Assets and Opportunity, studies show that 27 percent of all households don't have enough savings to cover basic living expenses for just three months if they suffer a financial setback. Industry experts recommend having a six month cushion, so I can only imagine the percentage of Americans that fall into this category.
Too many people underestimate the importance of having a savings account. I'll be the first to admit that it was never high on my priority list, but we all eventually learn from our mistakes. So why doesn't everyone have an emergency savings fund? The answer is simple: They spend more money than they earn and have trouble living below their means.
No Savings, Big Trouble
The absence of an emergency savings fund can lead to a severe financial setback. It's inevitable that unforeseen expenses are going to come out of the blue. So what happens if you're unable to pay for these expenses?
Some people resort to payday loans because of the "quick fix." Nowadays, you can literally apply for a payday loan on the web and get the money wired into your bank account the very next day. This is a temporary band-aid to the problem, not a solution. According to the Center of Responsible Lending, the average payday borrower ends up trapped in the loan for over a year and 44 percent of the borrowers become repeat customers. The average interest rates on payday loans are over 400 percent!
Another costly option is to charge it on your credit card. Unless you're paying off your balance in full every month, you're going to end up paying thousands of dollars in interest. For example, a $2,000 expense will take you over 2.5 years to completely pay it off (assuming a 20 percent interest rate). Assuming that you didn't have $2,000 in an emergency savings fund, it's a safe to say that you won't be paying off the balance anytime soon. Overwhelming credit card debt can easily spiral out of control. Without any savings fund, some people are left with no choice but to charge everything on their credit cards just to cover their daily expenses. Many of you probably know where this is headed towards, the dreaded "B" word: Bankruptcy!
Starting Your Rainy Day Fund
Now that I've got your attention, let's make sure none of this ever happens to you. Creating an emergency savings fund may seem like an impossible task, but having the will power to stick to a strict budget and controlling your spending is key. Here's a step by step guide on how you can create your emergency savings fund:
• Create a Budget: Look through your last three months of bank statements and categorize each expense. This is the first step in creating a realistic budget. Creating an unrealistic budget can make you feel demoralized and overwhelmed.
• Cut Back on Spending: After analyzing your spending history for the past few months, you should be able to pick up on specific spending patterns. Are you spending too much on coffee? Are you excessively eating out? Are you shopping for gadgets or items that you don't really need? The key is to cut back on areas where it seems probable. Someone can easily tell you that you're paying too much on rent, but how realistic is it to pack your bags and find a new home? Some of the most common expenses you can reduce immediately are cell phone bills, Internet/cable bills, utility bills, transportation and food costs.
• Contribute Monthly: It's hard to say exactly how much of your monthly income should go towards savings since everyone has a different lifestyle, but I always recommend that 60 percent of your income go towards "needs" (fixed costs), 25 percent of your income goes towards "wants," and 15 percent of your income goes towards savings. You might be wondering why your "wants" is higher than your "savings." The answer is simple. We all earn money so we can enjoy the things we want to do. Saving money doesn't have to seem like a chore, everyone should reward themselves for good financial behavior.
Your rainy day fund is your gateway towards financial freedom. Without it, you can be trapped inside a spiral of debt that can lead to filing for personal bankruptcy. Create your budget, minimize your expenses, and contribute monthly. It's that easy.