It's no secret that Americans are stressed about money. Approximately 58% of U.S. adults say their finances control their entire life, which is resulting in sleepless nights, fatigue, and difficulty concentrating at work, a recent survey from Capital One and The Decision Lab found.
Although there are many reasons people may feel stressed about money, there's one mistake in particular that nearly a quarter of Americans are making -- and it can easily derail your entire financial future.
The simple mistake that could cost you a fortune
One of the best ways to protect your finances is to build a solid stash of savings in case you're faced with unexpected costs. However, around 22% of Americans say they have less than $200 in savings, according to a recent survey from J.D. Power, including money in bank accounts, retirement fund investments, and all other sources of cash.
When you don't have a healthy emergency fund, you're putting your entire financial future at risk. Faced with a significant unexpected expense you can't afford to pay for, you may have no choice but to rack up credit card debt or take out a costly loan. If you have money stashed in your retirement fund, you may have to use it to pay your bills -- although that also has its consequences. If you withdraw money from your 401(k) or traditional IRA before age 59 1/2, you'll face a 10% penalty and income taxes on the amount you take out. Not to mention the fact that by withdrawing your cash before retirement, you'll be missing out on valuable time to let your investments grow uninterrupted.
In addition, while any type of debt can be dangerous, high-interest debt -- such as credit card debt -- is especially toxic. Credit card interest rates can soar above 20% per year, and you could potentially end up paying hundreds or even thousands of dollars in interest alone by the time your debt is paid off. Depending on how much debt you have, it could also take years before your credit card balances are fully paid off. If you face another major cost before the first one is repaid, you may be forced to dig yourself even deeper into debt.
Short-term loans can be even riskier, especially if you choose to take on a payday loan. These loans typically have to be paid back within a couple of weeks, and they come with sky-high interest rates -- sometimes higher than 400%. In many cases, borrowers find themselves stuck in a cycle of debt. In fact, with 80% of loans, the borrower either rolls over the loan or reborrows within 14 days. In addition, around 15% of new loans get renewed or rolled over at least 10 times, meaning you could end up paying hundreds of dollars (or more) in interest alone by the time your debt is fully repaid.
In short, if you incur an unexpected cost and don't have enough savings to cover it, you could end up spending far more than you should to pay for it. With an emergency fund, though, you can avoid these problems and keep your finances on track.
How to build a solid emergency fund
Even if you know you need an emergency fund, establishing one is often easier said than done. Most experts recommend saving enough to cover around three to six months' worth of general living expenses, and that can be a challenging task if money is tight.
If you're struggling to save, it may help to start small. Begin by saving just a few dollars per week, then see if you can gradually save more. You may need to cut back on some of your expenses, but the good news is that establishing an emergency fund is a relatively short-term goal. Unlike long-term goals such as saving for retirement (where you'll need to save consistently for decades), you may be able to build an emergency fund worth thousands of dollars in just a few years, depending on how much you're able to save each month. So, if you do need to make budget cuts, those cuts may be less painful when you know they're only temporary.
Another factor to consider is where you want to park your cash. Try to avoid saving your emergency fund money in your retirement account, a CD, or any other investment where there are penalties for withdrawing your cash before a certain time. But you do want your money to earn a relatively high rate of return.
For this reason, a high-yield savings account is a good option. These accounts typically offer interest rates of around 1% to 2% per year, which is far higher than the meager fraction of a percent you'd likely earn with a standard bank savings account. Your money is also protected against market downturns, and you can withdraw it at a moment's notice without facing any penalties.
Building an emergency fund may be relatively low on your list of financial priorities, but it can be a lifesaver if you're slammed with a hefty unexpected cost. By setting aside a healthy amount of cash for a rainy day, you can protect yourself against any financial challenges you may face.
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