How to Build an Emergency Fund in 5 Easy Steps
Building an emergency is one of the most important steps you can take toward improving your finances. In our world which is sometimes chaotic, we must expect the unexpected. Whether it’s the loss of a job, a sudden medical issue, or a home repair you can’t put off, an emergency fund helps ensure you will be able to cover those costs when inevitably happen.
1. Set a Savings Target
The first step toward building an emergency fund is setting a savings goal. The common recommendation is 6-8 months’ worth of expenses, but you certainly don’t have to have that upfront. If you are just getting started and don’t have a lot of money, you can start small and work gradually toward meeting your savings goal.
If you don’t know your monthly expenses, there are a number of ways you can figure out what they are. Here are a few of them:
- Check your bank statements and subtract all of your expenses from your total earnings for the month
- Use a budget spreadsheet to track your expenses and paychecks
- Use a budget app to track your expenses and earnings automatically
Once you’ve determined your monthly expenses, you will need to have some money left over to add to your emergency fund.
2. Set Some Money Aside From Every Month
Thanks to #1, you now know your monthly expenses. As a result, you know exactly how much you can afford to contribute to your emergency fund every month. If you’re just getting started, don’t worry if it’s not a huge amount - say $50 or $100.
While this may not seem like a lot, any amount is better than nothing. You can always increase the amount you set aside by increasing your income and/or reducing your expenses. The bigger the difference between your income and your expenses, the more you can set aside every month.
3. Use a Savings Account
A savings account is a great place to store your emergency fund. While this step is not exactly a requirement, it can be helpful for multiple reasons:
- Savings accounts can act as a buffer since you usually can’t spend that money directly. It may take two to three business days to transfer money to a checking account if your savings account is not with the same bank, which can lower the temptation to tap into it.
- Note that this is only true if your savings and checking accounts are with different banks, however. If they are with the same bank, the transfer may be instantaneous.
- Many online savings accounts have high interest rates, which allows your money to grow without the risk of losing it in higher-risk places, such as the stock market.
Also, note that most savings accounts are FDIC-insured for up to $250,000. Some are even insured up to $1 million.
Remember that the main purpose of an emergency fund is for that money to be available if you ever need it. As such, it’s important for that money to be protected from discretionary spending or any other forces that may threaten it.
4. Increase Your Income & Reduce Expenses
One of the ways you can bolster your emergency is by some combination of increasing your income and reducing your expenses. How quickly you want to build your emergency fund is entirely up to you, but this is one of the best ways to speed up the process if you so choose.
When it comes to reducing your expenses, it’s usually most productive to start with the “big three” of housing, transportation, and food (in that order). Reducing expenses in these areas can often make a big difference in your overall budget.
When it comes to increasing income, you can ask for a raise at your current job or pick up an extra job on nights or weekends if that is more your style.
5. Make it Automated
Many online accounts allow you to set up recurring transfers, and this includes savings accounts. You can set a monthly transfer of $50, $100, $150 - whatever you can afford - and that transfer will happen automatically without you even having to think about it.
Studies have shown that our emotions tend to influence how we manage our money; by making your money management automated, you take your emotions out of the picture. In fact, because you can make things automated, you can rest assured you are systematically building your emergency fund.
Start Building Your Emergency Fund ASAP
If you use these steps to build your emergency fund, you’ll be well on your way to protecting yourself against emergencies. But don’t put it off - as much as we hope an emergency will never arise, things happen.
The sooner you start putting extra money aside, the sooner you’ll be able to protect yourself if disaster happens to strike.