Late last year, I reported that a whopping 69% of Americans had less than $1,000 in savings -- which indicated that the majority of U.S. adults were ill-equipped to cover a major financial emergency. But new data reveals that, while most Americans are still considerably behind on savings, a growing number are more than prepared for the unexpected.
In a just-released Bankrate study, 31% of adults now have enough savings to cover six months or more of living expenses. What's also encouraging is the fact that, on top of that 31%, another 17% of savers have enough money in the bank to pay for three-to-five months of living expenses.
Of course, this still means that the bulk of Americans have a fair amount of catching up to do. But the fact that more people are recognizing the importance of having emergency savings is a step in the right direction.
Why you need that emergency fund
There's a reason we're all told to stash away enough money to cover a good six months of living expenses. You never know when you might fall ill, lose your job, or encounter some other scenario where you have no source of income for an extended period of time. Having emergency savings is the best way to protect yourself from the unexpected and avoid a trap that many folks inevitably fall into: credit card debt.
That's right -- those who don't save for emergencies typically have no choice but to charge expenses, as they arise, on a credit card. And this can very quickly lead to a seemingly endless cycle of debt.
Any time you use a credit card and don't pay off your balance in full, you immediately start accruing interest charges by the time it comes due. These charges are then added to your balance, at which point you incur -- you guessed it -- more interest charges. It's a scenario you most definitely want to avoid, and the best way to do so is to save appropriately for the unknown. No one is immune to emergencies, so if you're among the roughly 50% of Americans who don't have enough savings to cover at least three months of living expenses, it's time to get moving.
Building your emergency fund
Calculating your emergency fund is a relatively simple matter of adding up your monthly expenses and multiplying that figure by six. (Note: You can get away with saving just three months of expenses in certain scenarios. If you're a dual-income family, you don't own a home, and you don't have dependents, three months' worth of living costs might suffice. Six months' worth of expenses, however, offers much more protection.)
Don't forget to include one-time expenses when you compute your total. For example, if you typically pay a $1,000 life-insurance premium once a year and you haven't accounted for that cost in your emergency savings, you'll be in quite the bind if that payment comes due in the midst of a period of unemployment.
Of course, calculating how much you'll need for emergencies is the easy part -- saving up that money is much trickier. If your current budget doesn't allow for much in the way of savings, you'll need to take a long, hard look at your spending and find ways to cut corners. This might mean implementing a series of small changes -- say, dining at home more often instead of eating out, or giving up your weekly cab rides and taking the bus -- or making a couple of more drastic changes, like downsizing to a smaller, less expensive home.
You might also consider taking on a side job to help build your emergency savings. This way, you won't need to uproot your lifestyle, but you'll still be doing your part to protect yourself from the unknown. Remember, your emergency fund doesn't need to come together overnight. It might take months, or even years, to establish it fully, but as long as you're working toward that goal, you can rest assured that you're on the right track.
Finally, once you do start accumulating a decent chunk of cash for emergencies, be sure to stick it in an accessible savings account. While I'm generally an advocate of investing your money to generate growth, you shouldn't be taking any risks with your emergency fund.
You never know when an unplanned expense might hit when you least expect it. While you can't prevent the inevitable, you can do the responsible thing and build that emergency fund. It could end up being the smartest financial move you'll ever make.
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