An unexpected bill or periodic expense can wreck your budget, but it doesn't have to. There are two things in particular that people can do to prepare ahead of time for an unanticipated financial emergency.
Unexpected expenses, like car repairs or medical expenses, are one of the most frequent budget busters people face. While 82% of people report they do some household budgeting, fewer than 30% of people report that they have a long term plan that includes savings. If you don't have a savings plan, you're probably not ready for a financial emergency.
Imagine that your car breaks down, and the repairs will cost you $500. Are you prepared for that expense? If you're like most Americans, you're in trouble. According to a Bankrate study, only 38% of people have money set aside to cover an emergency expense of $500. You may need to borrow money or charge the debt on your credit card to cover the crisis. If you can't pay off the credit card immediately, the interest charges add additional costs.
The best way to handle unexpected expenses is to build an emergency fund. Set a goal to save $500 in your fund. It's likely you'll need it, as 63% of people report incurring a major, unexpected expense during the year. Ideally, financial advisors recommend having three to six months of salary set aside in an emergency fund.
There are several ways to amass your emergency fund, but the most important step is making the commitment to save. Try any of these strategies to build your fund:
Consider it a monthly bill and make an automatic transfer from your checking account to a separate account.
Set aside all $5 bills you receive as change when you break a larger bill.
Give up something you enjoy and set aside the money you would have spent on that activity.
Sell something you no longer use.
Supplement your income by doing odd jobs or getting a part-time job and save that pay.
Periodic expenses, such as membership dues or life insurance, can sneak up on you and leave you scrambling to come up with the payment.
Your monthly budget needs to include revolving savings for the expenses you can expect, but that don't occur every month. You can calculate the amount you need to contribute monthly for your revolving savings by doing the following:
Review your bank and credit card statements from the past year and identify those expenses that occur periodically, like property taxes, memberships and dues, furniture purchases, holiday spending, vacations, and back-to-school expenses. List these expenses and their cost.
List new expenses you will incur, like the baby shower you're hosting for your sister or that new grill you plan to buy.
Calculate what all of these expenses will cost for the year.
Divide the total by 12 and set aside this amount monthly as a revolving savings expense in your budget.
Set up a calendar reminder so you know when to expect these expenses. When it's time to pay, you'll have money set aside to cover it.
If you don't have the additional funds to set aside that amount each month, you're overspending on your basic monthly budget. It's time to revisit and rework your spending plan.
Emergency fund and revolving savings
You made the commitment, built up emergency savings, and added revolving savings as an expense to your monthly budget. Now, it's important to protect the money you've worked hard to amass so it will be there when you need it.
Set up separate savings or money market accounts for your emergency fund and revolving savings so you're less tempted to tap into these funds for a spontaneous shopping spree or weekend getaway. Then ignore it until you need it.
Stuff happens. Usually, that stuff will cost you money. Setting up categories in your budget for an emergency fund and revolving savings will prepare you for extra expenses when they occur.
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