No matter how much you budget, unexpected expenses are always lurking around the corner, waiting to throw a wrench in your short term and long-term plans. It can be something as simple as an unexpected car repair or something more sinister, like a natural disaster that destroys part of your home.
Here’s the thing: you don’t need to be held hostage by emergencies. An emergency fund can help cushion the blow from unexpected expenses. Whether you’ve tried and failed to build an emergency fund in the past or are coming with a blank slate, these six steps can help you save enough money to handle emergencies with ease.
Figure out how much you need
You should have enough money in your emergency fund to cover six months of spending.
If you just thought to yourself, "I’ll never have six months worth of income saved," you’re not alone. It’s a huge number that can appear unattainable, especially if you’re starting from zero or have debts to pay off.
Right now, take out a calculator. Take your monthly payment size and multiple it by six. Take that number and write it down on the top of a piece of paper. This is your goal, your end-game.
Sidenote: We’re not the only ones who suggest keeping six months of income in an emergency fund, and it’s good advice for most people. However, some financial situations may require that you have more or less money saved. For example, if you’re a freelancer with an unstable income, you may want to put more money aside for emergencies.
On the other hand, let’s say you have a long-term disability and short-term disability policy to cover loss of income that may occur from an unexpected illness or disability. You may not need as much saved in your emergency fund since you’ll have an income replacement.
Take that big goal and break it into smaller milestones
You don’t need to start with your end-game. Like everything in life, emergency fund saving can be broken down into smaller goals and milestones.
Start with a goal of $100. If you save $10 per week, you’ll hit that goal in ten weeks. That’s less than three months. Make your next goal $250. It will only take another fifteen weeks to hit that goal. By setting these smaller milestones, you’ll consistently feel satisfied and rewarded that your savings are accumulating.
Obviously, the more you can afford to save every week or month, the faster you’ll hit these goals. If you save $50 per month, you’ll be at $500 in less than a year.
You might be thinking, "Wow, it will still take me a long time to build up my emergency fund." That’s okay! Just like with paying down debt, building an emergency fund doesn’t happen overnight.
Open an account just for your emergency fund
You don’t want your emergency fund to be in your main checking account. This is crucial: you don’t want to accidentally spend your emergency fund. And since your emergency fund should mostly just be sitting in this account, you should find an account with higher interest rates than your average checking account.
An easy way to check off both of those boxes is to open up a savings account at your bank. Savings accounts typically have higher interest rates than checking accounts because there are monthly limits as to how many times you can transfer money out of the account. In other words: the money is less liquid, therefore, higher interest rates.
Another option is a money market account (not to be confused with money market funds). Money market accounts have traditionally offered higher interest rates than savings accounts. Money market accounts usually have higher minimum balances and minimum starting deposit. They also allow you to write checks from the account.
As banks have cut costs relating to savings accounts, they’ve been able to raise interest rates, becoming competitive with money market accounts. Some online banks, such as Ally, even offer higher interest rates on savings accounts than money market accounts. For your emergency fund, we suggest comparing the difference between the two at your chosen bank.
A riskier option is to put your emergency fund into an investment portfolio. Betterment, an online automated investing service, believes that you should put 130% of your safety net into an investment portfolio to insure that you beat inflation. The major downside of this is that your safety net is a lot less liquid than if its in a savings account. Betterment, of course, is also biased towards any financial plan that involves investing. We suggest that you take a look into an investment portfolio only after you’ve reached your end-game goal.
Set up an automatic transfer
Now that you have a goal and a separate account, figure out how much you can afford to put into savings every month. Depending on your financial situation, this may not be a lot at first. It may help to think about those smaller goals. If you can set aside $40 every paycheck, you’ll reach your first small goal, $100, in two and a half months.
Of course, you should try and put aside as much as possible, especially when you’re just starting to build your emergency fund. The faster you can build your emergency fund, the faster you can reclaim that part of your paycheck for a retirement fund or for travel.
Putting aside your savings shouldn’t be something you have to think about. Instead, set up an automatic transfer from your checking account to your emergency fund account. You could even set the transfer to take place on the same day you receive your paycheck. That way, you never have to think about putting that money aside, it just comes out of your paycheck.
Don’t spend it (unless it’s an emergency)
Let’s say you’ve got a tidy sum of $500 saved in your emergency fund. That’s great! Now let’s say you’ve got your eyes on that fancy new Apple Watch. Also great! And then let’s say you decide to spend your emergency fund money to buy that fancy new Apple Watch. Not great!
It might seem obvious that you don’t spend your emergency fund on anything other than an emergency fund, but for some people, it’s really hard not to spend a nice big sum of money when it’s just staring at them in the face.
Remember, you’re making the conscious decision to save money. Don’t blow it by spending your cash on things you don’t need. And if you really want that Apple Watch, put money aside somewhere else.
Use your debt snowball to fund your savings
If you’re also in the process of paying down debt (or have ever done so in the past), you may be aware of the snowball method. You can read more about it here, but quick capsule summary: you start paying off your smallest debts first, putting as much money as possible into that debt, while paying minimum payments on the rest. As you pay off debt, you keep adding money to the giant payment you’re making on debts. You know, like a snowball.
Once you’re done paying off your debt, don’t add that money back into your income. Instead, start adding to your savings account instead. If you’re using the snowball method, there’s a good chance that your snowball has or will grow to hundreds of dollars. Imagine how fast you’ll build your emergency fund with hundreds of dollars going into it every month!
If you aren’t using the debt snowball method, you can still use some of the advice we outlined in our guide. A major part of the snowball method is finding extra income, either by picking up odd jobs or cutting back on other expenses. You can do the same to put more money in your emergency fund.