When it comes to unexpected bills, such as car repair or medical bills, most of us are not prepared. And as financial disasters, such as a job loss or a debilitating medical condition, get more serious, the less prepared we are. A 2015 study from the Pew Charitable Trusts found that more than half of Americans are not prepared for unexpected bills. Another Pew study from 2015 found that 55 percent of American households did not have the cash savings to replace one month of income. While worrying about the unexpected will keep you up at night, there are some simple steps you can take to prepare your finances and ease your mind.
Understand your current finances: You can’t prepare your finances unless you have a clear picture of your income and spending. First, determine your average monthly income, including salary and any other money you bring in. Then list your average monthly spending, including everything from your student loan debt or car payment to what you spend on hobbies or entertainment. Add up all your spending and that is your total expenses for the month. If your income is higher than your expenses, then the difference is what you can apply to saving for the unexpected. If your expenses are higher than your income, then you need to evaluate your finances and find ways to reduce your spending.
Make an emergency budget: Once you have a clear picture of your finances, you need to calculate the minimum you need every month to cover your expenses. Start by prioritizing your bills. Look at your expenses and list just your monthly necessities. These are expenses you couldn’t live without or need to pay every month, such as rent, mortgage, car payment, groceries and utilities. Now list your optional spending, such as a gym membership, cable TV, eating out and Netflix. The total of your necessities is what you need on hand every month.
Examine your optional spending and see if there is anything you can drop or reduce. Instead of going out to lunch every day, go out every other day. Instead of the full cable package, go for the basic channels. Whatever is left on the list is now your emergency budget. If something unexpected does happen, the emergency budget is the first place you can go to drop the spending you can live without and lower your expenses.
Get your finances in order: With all your information in front of you, now is the time to evaluate your finances. If you have credit card debt, look to pay off or pay down your credit card balances. Keeping your credit card balances down gives you more available credit for emergencies. Is the interest rate on your mortgage high? You might be able to refinance at a lower rate. Make sure you’re contributing the full amount to your retirement fund or 401(k).
You should also check whether you are adequately covered with insurance. Check your health insurance to see whether you and your family have the right coverage in case of a medical emergency. Check your homeowners or rental insurance to make sure you are covered in the event of a natural disaster. Consider getting optional coverage such as life insurance or disability insurance to make sure you and your family are taken care of if the worst happens.
Build an emergency fund: One of the most important tools you can have to prepare for financial disasters is an emergency fund. Usually kept in a savings account, so you can easily access it when you need to, an emergency fund is money you set aside to cover your essential bills. The goal is to have at least enough money to cover you for three months. This money would go to living expenses such as food and rent. Most households don’t have that much, so don’t panic.
Even if you are starting from zero, having that total of your essential expenses gives you the number you need to reach. Contributing what you can afford each month will still give you that much more of a cushion in case of an emergency. Once you reach your three-month number, don’t stop contributing. Financial disasters can come in unexpected ways, so the more you have, the better your chances to make it through.