Wednesday, January 20, 2016

Emergency Savings



Most Americans don’t have enough money to cover a $500 emergency

Most Americans don't have the money to handle common emergencies like a car breakdown or a trip to the emergency room for a broken bone.

In a national survey by Bankrate.com, 63 percent of people said they don't have the savings to cover a $500 car repair or a $1,000 medical or dental bill. Only four in 10 Americans would be able to rely on savings to cover anything beyond their usual bills.

That suggests most people are living paycheck to paycheck, with common problems like a car accident or a sick pet upsetting their ability to pay. The survey found that only 23 percent thought they would be able to handle an emergency bill by cutting other spending.

Fifteen percent said they would cope by borrowing from their family. And 15 percent would depend on a credit card.

The findings echo others and show that most Americans are financially vulnerable. Although consumer confidence numbers gathered each month by the Conference Board show Americans feeling good about jobs after recovering from the Great Recession, most still aren't stashing money away regularly.

A Federal Reserve study of the "well-being of U.S. households" in 2014 showed only about half of people saving regularly in a separate account like a savings account.

In December 2012, as the fear of recession was still fresh, the savings rate in the U.S. climbed to 11 percent, according to the Bureau of Economic Analysis. But it fell to 4.6 percent in August and was at 5.5 percent in November. Prior to the 2008 recession and housing crash, Americans felt secure, and the savings rate dropped to just 1.5 percent when people were dipping into their home equity like a piggy bank — a practice that got many people into trouble when home values plunged.
Since the recession, people have been rebuilding their finances after millions lost homes and jobs and had credit cards and other borrowing shut off by banks. As the pressure has eased, they've become more likely to spend.


The Federal Reserve reported in 2014 that only 47 percent of U.S. households surveyed were saving for unexpected expenses. And if Americans were fortunate enough to end up with $1,000 in extra income, almost half would spend some of it. Only 17 percent said they'd save the entire amount, while 20 percent said they'd devote the entire amount to paying down debt.

The people most able to weather an emergency now are those with incomes over $75,000 or a college education, according to the Bankrate.com survey. Yet, even with incomes over $75,000, 46 percent said they wouldn't have the money to pay a $500 car repair. About 52 percent of people with college degrees said they wouldn't have $500 for the car emergency or $1,000 for an emergency room visit.
The issues seem to be both financial and behavioral. The St. Louis Federal Reserve reported that the median income of the middle class was 16 percent lower in 2013 than in 1989. But studies also have shown that people who are able to save are not doing it. In a survey by the Employee Benefit Research Institute, most Americans said they could afford to save $20 a week, or $20 more a week, but they didn't think it would matter.

Research done by Annamaria Lusardi, a George Washington University economist, shows that only a third of Americans understand compounding. In other words, they don't know that if they borrow money and are charged interest, paying off their debts becomes difficult as interest builds on old charges left hanging.

In a study of millennials just done with PriceWaterhouseCoopers, Lusardi found that 53 percent had carried over a balance on their credit cards without paying off charges fully. Nearly 30 percent were overdrawing on checking accounts.

If they had to come up with $2,000 within a month, only half thought they could do it. While many of the millennials surveyed were confronting financial challenges such as student loan debt, Lusardi found that only 24 percent demonstrated basic financial knowledge.

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Why You Absolutely Need an Emergency Fund

One important step in preparing for your future financially is building up an emergency fund. One interesting story on NPR on the subject, “Study: Nearly Half In U.S. Lack Financial Safety Net,” emphasized the importance of saving up an emergency fund and discussed the fact that far too many Americans still don’t have one. An emergency fund must be in place before you can be effective with many other aspects of your finances.

Here are 3 reasons why setting up an emergency fund is important:

1. You have something to fall back on when an unexpected expense arises.
2. You avoid going into debt or pulling from retirement accounts if you are in need of funds.
3. You have peace of mind that if something were to happen to your job you could maintain your lifestyle (for a given period of time).

Getting Started

You might have heard the general rule of thumb about an emergency savings account; set aside between 3-6 months of necessary expenses. Some people feel more comfortable with a year’s worth on hand, and that’s okay too. Be sure this money is accessible--put it in cash or a short-term savings vehicle. That is important because you want to be able to withdraw it today if necessary and be sure it won’t lose value.
It’s not always easy to start an emergency savings account, and some folks are trying to change that, which I’ll get to in a moment. Even if you only have a few hundred dollars to set aside, that is a very important first step. If you just added $20 per week to your emergency account, after a year you’d have $1,040.

Rewards for Saving

Fortunately, there are things being done to promote savings and help people get ahead. Of course, SaveUp is one example; not only are they rewarding people to save, but some of their prizes are focused on the establishment of emergency savings such as a “Rainy Day Fund” worth $25,000 or a “Deposit to Savings,” totaling $50,000. SaveUp’s model is based on a prize-linked savings mentioned in the NPR story. Prize-linked savings accounts, which give you a chance to win a grand prize when you save, is offered though some credit unions, but is still illegal in most states.
Other states and organizations are catching on too. A bill has even been introduced to Congress that would allow financial institutions to offer these types of incentives to encourage Americans to save for the future.
You can do your part by personally making emergency savings a priority, and of course, continue to SaveUp!
This post was written by SaveUp’s personal finance contributing writer, Catherine Hawley, CFP®.
 

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