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There’s been much talk in the news lately about whether we’re headed for a recession or if we’re already in one. A recession, according to the National Bureau of Economic Research (NBER), is defined as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
As Americans navigate this period of economic uncertainty, it’s clear that having emergency savings is more important than ever. As we brace for a possible downturn, one of the best ways to combat the financial effects of a recession is to set money aside for future use when times get tough.
Saving money is no easy task, especially with rising costs seemingly everywhere due to rising inflation. In October 2022, the Consumer Price Index (CPI) rose 7.7% compared to one year ago. The CPI measures changes in the cost of consumer goods. A quick trip to a grocery store, gas station or other retailer reveals just how much more expensive everything seems to be.
Keep reading to learn more about whether we’re headed for a recession and how to build an emergency fund that can withstand economic hardships in the future.
Are We Headed for a Recession?
Experts seem to be divided on whether a recession is looming and how devastating it might be if it does occur. A recent Reuters poll of economists showed an increasing view that a global recession is on the way. Goldman Sachs CEO David Solomon was recently quoted as saying, “There’s a reasonable chance of a recession in the U.S., but it’s not certain.” Earlier in November 2022, though, White House Chief of Staff Ron Klain said the U.S. is not in a recession and spoke of the growing strength of the U.S. economy.
Why an Emergency Fund Makes Sense During a Recession
An emergency fund is a building block of any sound financial plan, regardless of your situation. Emergencies are a fact of life. It’s often not a matter of if they will happen but when they will occur.
During a recession, the financial stakes are higher, and there’s more uncertainty. What seemed like a stable financial situation could turn dire, especially if an economic downturn leads to job loss or other hardships. Having a fully-funded emergency fund may be the only thing that keeps your head above water when times get tough.
Another reason to build an emergency fund or increase your current fund is rising costs. As inflation continues to rise, costs have skyrocketed on everything from food to everyday expenses to monthly utility bills. On November 2, 2022, the U.S. Federal Reserve (FED) announced its fourth consecutive 0.75% interest rate hike in an effort to curb inflation. Whether the rate hikes will be effective or not is still up in the air. The reality for many Americans, though, is that rising costs have left less wiggle room in the monthly budget. Tucking money away now is a simple way to combat future inflation if prices continue to rise.
Building an emergency fund now can also help you take advantage of competitive interest rates on savings products. Banks are raising their rates in an effort to drum up new business and secure more deposits. Setting aside funds now will allow you to take advantage of unusually high rates on savings, money market and CD accounts. Your savings continues to grow over time thanks to compound interest. The longer you can leave those funds untouched, the more interest you can earn.
How Much Money Should You Keep in an Emergency Fund?
Most experts say your emergency fund should be the equivalent of three to six months of expenses. With a possible recession on the horizon, there’s a case to save even more.
Two factors you should consider when determining how much you should save for emergencies are your current employment situation and your financial situation. As thousands of Americans learned during the pandemic, job security can quickly go out the window as companies scramble to save money and consolidate their workforce. If a recession could affect your employment, consider saving more money to prepare for potential job loss.
Your financial situation also plays a role in how much you need to save. Your current budget may not offer much cushion if you face hardship due to a recession. Look at your income versus monthly spending to see if there are funds available now to put towards emergency savings.
If you’ve already built up savings, you may only need to bump up your efforts, not start from scratch. Consider whether there are opportunities to funnel savings to an emergency fund temporarily
Tips for Building an Emergency Fund
Building an emergency fund can take time, especially if you plan to save several months’ worth of expenses or have little margin in your budget to fund the account. Here are some steps to take to get your emergency fund started.
1. Determine How Much You Need to Save
While experts recommend keeping three to six months’ worth of expenses in your fund, ultimately, it’s up to you how much you want to save. Consider your financial and job situation and set a savings goal that provides the level of comfort and security you desire.
Look over your monthly budget to determine how much you spend each month on expenses. This can include housing costs, utilities, food, transportation, childcare and other necessities.
Multiply your monthly expenses total by the number of months you want to save for to get your total emergency savings goal.
For example, if your monthly expenses are $3,000 and you want to save six months’ worth of expenses, your savings goal would be $18,000. For a year’s worth of emergency savings, you would need to save $36,000.
2. Open a New Bank Account
Start by opening a new savings or money market account. Shop around to find the best savings account or money market account to park your cash. You want to find an account that earns a competitive interest rate since the funds will (hopefully) sit there long-term. Using a separate bank account for your emergency fund is important because it keeps your emergency money separate from your everyday spending. It’s also a great way to track progress as you get closer to your savings goals.
Plus, some financial institutions offer an initial sign-up bonus for new customers, which can be a helpful way to build your nest egg more quickly.
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3. Automate Your Savings
One of the best ways to save for an emergency is to automate your savings. Make your emergency fund a line item in your budget, like a car payment or the water bill. As you save each month, it becomes a natural part of your financial plan. Many banks allow you to set up automatic transfers from your checking account to your savings account. You can also talk to your employer about routing a portion of your direct deposit paycheck to your new account. Find a method that works for you and stick with it at least until you reach your goal.
4. Reduce Your Spending
You may need to find ways to create more margin in your budget to build up your emergency savings. Start by looking over your spending habits for the past few months. Look for areas of overspending or expenses you can cut out to save money. This doesn’t mean you need to cut out every indulgence, but making temporary sacrifices can help maximize your savings efforts and help you reach your goal quicker. Budgeting apps can help you track historical spending habits and find areas of concern.
5. Look for Other Ways to Save Money
Your current income may not be enough to help you reach your goal in a timely manner. To reach your goal quicker, consider temporarily picking up more hours at work, getting a part-time job or starting a side hustle. Consider your schedule and other obligations to determine how much time and effort you can afford to spend to generate more income.
You can also generate more income by selling items you have laying around the house. List items on Facebook Marketplace or eBay to make extra money. Another way to quickly build savings is to take advantage of windfalls that occur during the year. If you receive a tax return check from the IRS each year, deposit it into your emergency fund account. Do the same with bonuses received from your employer or other unexpected sources of income that may occur.
Be Prepared Whether There’s a Recession or Not
You can’t go wrong building an emergency fund. Whether the country enters a recession or the economic climate improves, you’ll have money socked away for when emergencies happen in your life.
Determine how much money you need to save to provide security for yourself and your family should you face a hardship or emergency. Consider your job situation and your current and future financial situation as a guide to the right size emergency fund.