Updated: Apr 9, 2020
Life is unpredictable. And surprises are often reasons to celebrate. But when the unexpected brings additional expenses or a loss of income, it helps to have a plan.
Here are five steps you can take to prepare for a financial emergency.
1. Know Your Expenses
During a financial emergency, you might give up extras like going to the movies or eating out, in order to focus on the essentials. Knowing in advance how much you spend—and where you can save—might make it easier to deal with an unexpected expense or a loss of income. Try keeping track of your expenses for two or three months. This should give you a good idea of how much you typically spend—and where your money’s going. You can write down all of your expenses on a sheet of paper, make a list on your phone or use an online budgeting tool. Next, divide your expenses into two categories: essentials and extras. Essentials include things such as housing, food and utilities. While extras might include streaming services, nights out and hobbies. These two lists can provide clues about ways to save in an emergency. And you’ll also learn how much money you need to cover your most important monthly expenses.
2. Start an Emergency Fund
An emergency fund can help you pay for unexpected expenses. It can also help cover essentials if you experience a temporary loss in income. Some experts recommend saving three to six months’ worth of expenses. But the amount in your emergency fund could depend on your personal needs. Once you’ve identified how much you need to cover essentials for a few months, set a savings goal. Start small and work in steps to set money aside in a checking or savings account each month—you don’t have to put it all away at once. Pro tip: By putting aside extras, you may be able to reach your savings goal faster. If you receive a bonus, a commission or a gift from a relative, consider putting it toward your emergency fund. A tax refund is another great opportunity to boost your savings.
3. Consider the Role of Credit
In an emergency, you may want multiple ways to pay for expenses. One option is a credit card. While a credit card isn’t a replacement for emergency savings, it may help you pay for some unexpected expenses or cover essentials if you’ve exhausted your savings. If you’re planning to use a credit card for emergencies, make sure to understand how credit cards work and how to use them responsibly. You should also consider what features are important to you in an emergency credit card. You may want to look for a card with a low annual percentage rate, low or no fees, and a credit limit that’s high enough to cover your most important expenses in an emergency.
4. Take a Look at Your Insurance
Insurance is one way to manage financial risks that come with unexpected life events. What insurance policies do you have? Do you know what they cover? And do you have the coverage you need? Start by taking a close look at your policies to make sure you understand what’s included. Check the fine print on all your policies to identify places you could save. Your health insurance may offer opportunities to lower your out-of-pocket costs. Your car insurance could offer roadside services you were unaware of. And you may be able to bundle some insurance policies for lower rates. It also helps to know the limitations of your coverage. Some homeowners insurance, for example, might not cover damage from flooding caused by the weather. If that’s a risk you want to manage, check your policy and consider whether you need flood insurance.
5. Create Extra Income Streams
Ever consider a side hustle? Extra income can help you prepare for a financial emergency in several ways: You could grow your savings, pay down debt or cover your essentials if your primary income stream takes a hit. The gig economy offers plenty of opportunities for side hustles and one-off jobs. You might offer to pet sit, walk dogs or mow lawns. You could drive for a rideshare company. And you could even list a room in your home on a peer-to-peer, short-term rental site. Want more side hustle ideas or inspiration for work-from-home jobs? Consider what skills people might pay you to share. Adjusting to some life events can be difficult. But by being aware of your current finances and planning for an emergency, it may be easier to face the unexpected. The right financial plan could even lead you to the rainbow after the storm.