The most important financial New Year's resolution you can make

Many Americans make New Year's resolutions, and they often have to do with financial goals. Some are rather vague, such as "save more money," while others are very specific, like "save $1,000 in an IRA" or "pay off $2,000 in credit card debt."

Whatever your financial New Year's resolution may be for 2018, there's one step that's even more important to take: establishing and building up your emergency savings.

Why an emergency fund is so important

Simply put, unexpected expenses happen more often than we like to think, and many people are ill prepared to deal with them. Sixty-three percent of Americans say they experienced a "financial setback" in 2017, according to the National Endowment for Financial Education. Also, according to a Federal Reserve report, half of Americans can't handle a $400 expense without borrowing the money or selling something.

Here's the point: Let's say that your New Year's resolution is to pay off $1,000 in credit card debt. Then, in January, your car breaks down and needs $500 in repairs. Since you don't have any emergency savings, your $1,000 in credit card debt quickly becomes $1,500, making your resolution far less achievable. On the other hand, if you had some money stashed aside for situations like that, you could continue to pay off your credit card as planned.

As a personal example, early in 2017, lightning struck a tree in my backyard. It was damaged in a way that immediately threatened our house, so having the tree removed as soon as possible was absolutely necessary. Fortunately, we were able to have a tree service deal with it before it fell, but the bill was over $700. Thanks to having emergency savings, we didn't have to put it on a credit card, nor did we have to alter our retirement savings contributions in order to cover it. 

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Sitting on the markets sideline

While the stock market is soaring to new highs, half of Americans are being left out of the gains. Bankrate found that only 46% of adults have money invested and only 18% of the youngest adults are involved in the market.

While many people fear losing money, the true concern should lie in missing out a potential fortune. Over the long-term, a well-balanced portfolio will always come out with a net gain. With compound interest at stake, investing as early as possible is the smartest move. 

If you're not already in the stock market, now is the time to start. If you have a longer investment period in mind, it could make sense to take on more risk.

Not having a rainy day fund

There are so many things that can go wrong in life and someone who is smart with their finances will be prepared for anything. Expensive emergencies like a car breaking down or a medical emergency can happen whether you are ready for it or not.

Experts recommend your emergency savings be able to support you for three to six months. That's a conservative estimate for how long it takes to find a new job after being fired, for instance.

Having enough money in an easily accessible emergency fund prevents you from taking out loans in desperation or from going into debt.

Waiting to pay off debt

After investments and emergency savings, you may feel your paycheck dwindling. That feeling will only get worse if you don't pay off outstanding debts. 

From student loans to mortgage payments, debts are pesky. But the thorn will only get sharper over time if you ignore them.

A team of researchers writing in the Harvard Business Review this year suggested paying off the largest debts with the highest interest rates first. Credit card interest rates are notoriously high, so paying those off before going after more manageable debt, like student loans, may be a smart move.

If you're stressed out by debt, these strategies may help.

Not asking for a pay raise

Bankrate found that only 48% of working Americans got a bump in salary over the last year, and often because they aren't asking for it. 

Chickening out of a salary negotiation, especially at the beginning of your career, could cost you $1 million in lifetime earnings.

By understanding your worth and the value you provide at work, you can earn more every year and maybe even retire early. If your company won't give you that raise, it may be time to search for a new job where you are payed in accordance to your value.

Spending too much money

Overspending is a problem many people fall victim to, but you shouldn't spend all the money you make, according to Eric Roberge, a certified financial planner and founder of Beyond Your Hammock

"Spending right at your means, even if you don't go over and spend more than you earn, is like trying to take a race car up to 200 miles an hour with a warped wheel," he wrote in an article on Business Insider.

"If anything goes wrong — you hit a bump, you swerve, whatever — you're done. There's no second option when you're going full throttle in your financial life. There's no safety net."

Leaving room in your budget to save some of your earnings will set you up so you're not scrambling for money when you need it most.

In other words, learn to live below your means.


How much do you need?

The "industry standard" recommendation among personal finance experts seems to be six months' worth of expenses. If this seems like a large amount of money, you're probably right. This means that ideally, you should aim to save six months' worth of:

  • Mortgage or rent payments
  • Insurance payments (Car, home, life, etc.)
  • Utility payments
  • Car loan payments
  • Groceries
  • Other recurring expenses (pest control, alarm system, etc.)
  • Debt payments (such as credit cards)
  • Gasoline
  • Routine vehicle maintenance

Of course, the six-month target isn't ideal for everyone. Your ideal emergency savings needs could be higher or lower. For example, if you and your spouse both have stable jobs and little debt, a three-month emergency fund could be more than sufficient. On the other hand, if you are the sole earner in your household and/or don't have a stable employment situation, more than six months' worth of expenses may be a smart idea.

You don't need to get there overnight

Even a three-month emergency fund may seem impossible if you're starting from zero, but don't give up. You don't need to get there overnight, or even quickly. My wife and I built up our emergency savings for years before we felt like we had enough.

The good news is that an emergency fund of $1,000 should put you in a position to handle most unexpected expenses, so this could be an attainable goal for 2018. If this sounds too aggressive, aim for $500, which would put you in a better position than about half of Americans, according to that Federal Reserve data.

How to make it happen

If you don't have much emergency savings yet, the smartest financial New Year's resolution you can make is to start, or add to, your emergency fund. My suggestion is to come up with a specific goal for the year ($1,000, $500, or some other number) and divide it by the number of times you get paid in 2018. (Note: If you get paid every two weeks, this is 26.)

For example, let's say that you want to save $500 and you get paid twice per month, or 24 times per year. This means that if you set aside just $21 out of every paycheck, you'll hit your emergency savings target by the end of 2018.

We all hope that the unexpected doesn't happen, but the reality is that flat tires, veterinarian bills, and trees leaning toward your house can and do happen, so it's best to be prepared. Furthermore, a solid emergency fund will put you in a better position to achieve your other, more exciting, financial goals.

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