Most financial experts recommend building an emergency fund that could cover several months’ worth of expenses in the event you lose your job. But how much should you save exactly, and what do you do with your leftover money once you’ve hit your savings goal?
Let’s take a closer look at how much to save in your emergency fund, as well as what to do after you’ve finished building it — specifically…
- How much to save in an emergency fund
- What to do after you’ve saved an emergency fund
- Why the best time to start saving is now
Since your income and expenses might not be the same as everyone else’s, your emergency fund goal will likely be different, too. When deciding how much to save, think about how much money you would need to cover three to six months’ worth of expenses.
Note that you’re not necessarily looking to replace your current income, but rather you just want enough on hand to cover your essential costs. These include necessities such as…
- Mortgage or rent
- Utilities, such as electricity, heat and water
- Internet and phone bills
- Car payments and insurance
- Health care costs
- Debt payments
You don’t necessarily need to account for discretionary spending, such as restaurant bills or shopping, since you could cut these expenses out in the event of an emergency. But you also want to be realistic about how much money you’d need to stay afloat in the event you lost your job.
Avoid making your emergency fund too big
While it might be tempting to keep saving once you’ve gotten in the habit, it’s not a best practice to make your emergency fund too big.
That’s because even high-yield savings accounts are unlikely to pay a higher interest rate than what you’re charged on credit cards or most student loans. And in some cases, the savings account yield could be below the consumer inflation rate, meaning your savings would lose some of its real value over time.
Once you’ve hit your emergency savings goal, turn your attention to other savings and debt-payoff goals instead, as detailed below.
Most financial experts recommend living off a certain percentage of your income and putting the rest toward savings or paying down debt. What percentage? The exact number varies from expert to expert.
“I like to advise clients to follow the 60% rule,” said Magdalena Johndrow, a financial expert who specializes in helping millennials invest at Johndrow Wealth Management. “Keep your expected monthly living expenses to 60% of your income and place the remaining 40% into four savings buckets.”
As for what to do after your emergency fund, Johndrow recommended grouping your subsequent savings goals into short-term, long-term, retirement and fun categories.
The exact percentage you’re able to save might vary. If saving 40% of your income is impossible on your current salary, start with a number that makes more sense for your budget today.
Hopefully, your earnings will eventually increase thanks to a promotion, a new job or extra side hustle money. Whenever you earn a pay raise, revisit how much of your income you’re able to save.
No matter how much you’re able to save each month, the concept is the same. After you’ve set aside a portion of your budget for living expenses, here are a few goals to work toward:
Once you’ve finished building your emergency fund, turn your attention to paying off debt. Not only will paying off debt free up more of your monthly income, but it could also improve your credit score. Improving your credit score can make it easier to qualify for loans and snag better interest rates.
To save the most money on your debt, start by targeting high-interest debt, such as credit card balances. Once you’ve tackled high-interest debt, move on to loans with a lower interest rate, such as student loans.
For most loans, you can make extra payments without penalty, thereby getting out of debt faster and saving money on interest. However, you may also have other financial goals, so it’s important to strike a balance between paying off debt and saving.
Some borrowers, for instance, might hate having student loan debt hanging over their heads and wish to pay it off as fast as possible. Others prefer to invest their extra income, since they expect to make more money investing than they’d spend on student loan interest.
This guide goes more into detail about how to strike a balance between paying off student loans and saving for retirement.
Earmark a portion of your savings for short-term goals. What you classify as short-term goals will depend on where you expect life to take you in the next five years.
Maybe you want to take a big trip around the world, buy a house, save for a wedding or make a cross-country move. Whatever your goal, the money in your short-term savings “should remain uninvested or invested very conservatively, depending on your personal risk tolerance,” said Johndrow.
Investing your money always carries some risk. If the market dips, your savings will lose value. You can afford to be more aggressive with long-term investments because you have time to let the market rebound if it takes a tumble.
For short-term savings, however, you don’t have that luxury. An online savings account or certificate of deposit is a safer way to stash savings you’ll need soon.
After an emergency fund, what’s next includes thinking about your expenses in the next decade. They could include anything from an investment property to a new car or even capital to start a business.
For these types of savings, consider an investment account. “Investing long-term savings is important given inflation,” said Johndrow.
Inflation refers to the increase in the cost of goods and the decrease in the purchasing power of your dollar. Investing your long-term savings offers the opportunity to yield greater returns and help your money retain its worth.
“You should want any long-term savings to grow at a rate outpacing inflation in order to retain the purchasing power of your dollar for future purchases,” Johndrow said.
There are many different long-term investment strategies you can use, but the important thing is to pick one and stick with it.
Your retirement fund is not the same as your long-term investment fund.
For long-term savings, you need to choose investments that allow you to withdraw money at any time without penalty. Retirement saving accounts, such as a 401(k) or IRA, come with special tax advantages — but they also charge fees or tax penalties if you withdraw before you reach a certain age.
When you’re deciding how much to save in this bucket, your first priority should be maxing out your employer’s 401(k) match if your job offers this benefit. If you have additional money to save, Johndrow advised putting at least 10% of your total income toward retirement savings.
If you don’t have a retirement savings account yet, it’s time to create a retirement savings plan you feel comfortable sticking to.
Not all your savings goals have to be serious — don’t forget to budget for a little fun. This savings category can be used for things such as concert tickets, a short weekend trip or new hobbies you want to pursue.
By creating a special savings category just for fun, you’ll be less tempted to dip into your other savings when an impulse purchase happens.
If you’re not sure how much money you want to commit to your “fun fund,” consider saving incremental amounts using an app. Apps such as Digit will automatically put aside a few dollars of your money every day, so you’ll have savings waiting for you when you need them.
When thinking about what to do after you’ve saved your emergency fund, it’s tempting to splurge — but the best time to start moving toward the goals above is right now.
Saving and paying off debt are habits and lifestyle choices. If you start now, you’ll be that much closer to making the big purchases you’ve been dreaming of.
If you need some assistance managing your budget as you work toward these goals, these expense tracker apps will help.
Rebecca Safier contributed to this report.
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