When it comes to emergency funds, the end goal is clear. Most people think three to six months of living expenses provide a good amount of cushion. A fund this large can handle several unexpected expenses back-to-back, and it may even provide a backup if you lose your job.
What’s less clear is how to save this much. You know enough you won’t be able to save it all in one lump sum. That is, unless you win the jackpot and suddenly have thousands of excess cash on your hands.
For the average person, building an emergency fund is an exercise in patience. You have to make small contributions over time to save up that much. So, just how small are these contributions, and how frequently should you make them? Let’s find out.
The Standard Savings Rule: 20%
The 50/30/20 budget is by far one of the most popular budgeting methods out there today. It offers a simple and quick way to identify and limit major spending categories.
As its name suggests, you should split your income into three categories: 50%, 30%, and 20%. The breakdown works as follows:
50%: You should spend half of your take-home pay (your paycheque minus taxes and other deductions) on essentials. This includes the typical stuff like rent and mortgage payments, groceries, and utilities.
30%: A balanced budget reserves some cash for the fun stuff. You should limit your non-essential discretionary spending to 30% of your take-home pay.
20%: The remaining 20% of your take-home pay is therefore available for savings. When you’re first starting out, all 20% may go towards your emergency fund. This fast-tracks these special savings, so you can be prepared when things go wrong.
Splitting Your 20% Between Multiple Savings Goals
Once you save your first $1,000 or so, you might reconsider how much of your 20% goes towards your emergency fund.
What else do you have to save for? Most people want to set aside money for retirement, as well as sinking funds that help afford big purchases in the future. Sinking funds most often take the big goals like buying a home or car, but they can help with vacations, new sound systems, and furniture, too.
How you split your 20% between these many objectives is personal; however, some financial advice suggests your retirement fund should get about half of it. That leaves 10% for emergencies and sinking funds.
But Wait, There’s Another School of Thought
Some people think the 20% in the 50/30/20 breakdown has to stretch even further to include debt payments. This school of thought recommends splitting the 20% between all your savings and extra debt payments.
The word extra is crucial here, as it makes an important distinction. All the scheduled, pre-determined, or minimum payments on personal loans or lines of credit fall under the 50% category for essentials.
Why? Missing these payments can result in late fines, interest accrual, and even credit damage, so you must cover these payments to uphold your end of the loan contract.
Why Paying Extra Can Be a Good Idea Sometimes?
While paying the minimum protects your account from late penalties, it’s not the most efficient way to pay off debt. These minimums tend to be small, manageable amounts, so you might find it easier to fit them into your budget without feeling stretched thin.
Since they’re a small fraction of what you owe, you have to make more of these payments over time before you see this balance drop to $0.
According to the online lender Fora, borrowers should always pay more than the minimum on a line of credit when possible. Larger, more frequent payments free up your limit faster, so it’s available again in an emergency. Depending on how interest accrues, paying your debt sooner may also reduce what you pay overall.
Should You Always Make Extra Debt Payments?
Some lenders may apply a pre-payment penalty for making any additional payments outside their pre-determined schedule. It’s up to you to crunch the numbers to determine if the pre-payment penalty is less than the interest you will save.
Not all personal loans are the same, so calculate this difference for each account; extra payments don’t always make a difference to the interest you accrue over the lifetime of the loan, too. If you aren’t sure how interest works on your loan, call your lender to discuss your account and their pre-payment policies.
What if You’re Finding it Hard to Hit the 20% Target?
If you decide to pay off debt with your 20%, you have to stretch this amount to cover your loans, emergency fund, retirement fund, and sinking funds. Juggling this many goals at once can be challenging, and it leaves less money for your emergency fund.
Saving less means each month means you will take longer to achieve your ultimate goal of three to six months of living expenses. If you can’t afford to delay your emergency fund, you can speed up your savings by trying out the tricks below:
Reduce Your Discretionary Spending
If you want to save more, you can siphon some money from your 30% category. You can limit how often you go out for dinner and concerts to free up cash. Other ideas include:
- Cancelling most of your streaming subscriptions.
- Avoiding splurge spending at the grocery store.
- Limiting your beauty care spending.
Go as low as you believe is realistic. Limiting your discretionary spending may be a logical way to save money, but this plan can be hard to execute. Most people need some novelty or pick-me-up to tolerate other sacrifices. Spending $0 on discretionary expenses may only make sense in rare situations when you’re struggling financially.
Get a Side Gig That Funds Your Savings
Don’t worry — if you want to save a lot of money without sacrificing the fun stuff, you can have the best of both worlds. Plenty of people add a side gig to earn a little extra cash. Whether it’s a hobby-turned-paycheque or a part-time job at a diner, you can deposit your paycheques directly to your emergency fund.
Bottom Line:
Ultimately, the exact dollar amount you save is personal. This number reflects what you need to feel financially secure. But if you’re finding it hard to quantify security, the 50/30/20 budget offers some insights. The general rule of thumb is to save up to 20% of your take-home income. Keep this in mind as you setup automatic savings contributions. This percentage can help you strike a good balance for your budget.
Be the first to comment