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Emergencies happen. A loss of income, an unexpected medical bill, an urgent car or home repair—it's the stuff of life. But each of these can be extremely stressful and damaging to your financial health when you don't have the cash to make it through.
That's why having an emergency fund—money set aside specifically to cover your needs in the event of a crisis—is key to financial success. Not only can it help you stay afloat when the unexpected happens, but there's also a psychological benefit to knowing you'll be able to survive in an emergency without going into debt. Here's how to build an emergency fund in six steps.
1. Create a Budget
Before setting savings goals, take a close look at your current spending. Tracking your spending and starting a budget will help you set savings goal posts—more on this below. Even more fundamentally, a budget will help you direct your spending toward your goal.
A budget is a plan for your money that takes into account how much cash you have coming in, your necessary expenses, how much you plan to spend and, importantly, how much you'll save. Starting a budget with establishing an emergency fund in mind will help you come up with a saving baseline that works for you.
2. Calculate How Much to Keep in Your Emergency Fund
Experts suggest aiming to keep anywhere from three to six months' worth of basic expenses in an account you can access easily, such as a high-yield savings account. You may aim to save more than that, depending on individual factors, like having a variable income.
Base your emergency savings goal on your bare-bones expenses, not your average spending. In the event of a true emergency, you'd cut your spending down to just the essential stuff, without discretionary spending. So, just tally up what you spend on housing, utilities, basic food, care for children and pets, transportation and other essentials.
Find High-Yield Savings Accounts
3. Set an Attainable Goal
Saving for a major goal, such as a robust emergency fund, is easier when you set smaller, reachable goals. Six months' worth of expenses is a lot of money, which can be discouraging. But the key is to start where you're at.
Take inspiration from these small goals, and tweak them to fit your situation:
- Save $100 by the end of the month.
- Save $1,000 by the end of the year.
- Save one month's worth of basic expenses by the middle of next year.
Once you reach that first goal, you'll have a springboard that can motivate you to reach a larger savings goal next.
Learn more: How to Set Financial Goals
4. Automate Your Savings
It's a savings truth universally acknowledged: If you don't pay yourself first, you likely won't pay yourself at all. In other words, make sure your savings is automatically transferred from your checking account to your savings on payday. Otherwise, you may find that after covering your expenses and doing some spending, you haven't enough left to save.
How much should you put away from each paycheck? The answer depends on your personal financial picture, but the key is to be consistent. So, if you can afford to transfer $200 each paycheck into your emergency fund, then that may be a good number for you. If you can only afford a smaller amount, such as $50, start there.
Tip: You may be able to set up a split deposit through your employer's payroll, which will allow you to automatically route a portion of your paycheck directly into savings. If it's money you never see, you won't be tempted to spend it.
5. Look for More Money to Save
As you get into the habit of saving more and spending less, you may be able to up your contributions to your emergency fund over time. Take into account all your savings goals when calculating how much you can set aside for emergency savings.
One rule of thumb is to save around 20% of your gross income. That number typically includes your retirement contributions as well as other savings goals, such as money for a down payment on a car or home and your emergency fund.
On top of upping your savings ratio gradually, take advantage of any windfalls you receive by funneling them directly into your emergency fund. If you receive a tax refund or a holiday bonus, for example, put it into your emergency fund. Is it the most exciting use for unexpected cash? Perhaps not, but you'll reach your goal for increased financial well-being faster.
Learn more: Simple Ways to Save Money
6. Keep Your Emergency Fund Liquid
As you increase the balance in your savings account, you may be tempted to invest those funds. But it's wise to keep your emergency fund liquid, rather than tied up in investments.
While investing your money can bring higher returns, it can also come with losses, especially if you have to sell quickly in the event of an emergency. That probably isn't worth the risk.
Instead, keep your emergency fund in a liquid account, such as a high-yield savings account, where it will yield higher interest than the average savings account does but still be available for withdrawal in the event that you need it.
Learn more: What Is an Emergency Fund Used For?
Keep Calm and Save Money
Building an emergency fund with enough to cover at least three months of basic expenses is a huge win for your finances. Being able to make it through an emergency without going into debt means more financial stability. Celebrate the win—and then keep saving.
Beyond establishing an emergency fund, come up with long-term financial goals. You might want to save for a house, invest in equity-boosting home improvements or achieve retirement savings goals.