How do you start an emergency fund? And why do you start an emergency fund?
When your tire blows out on the highway, you fracture your ankle on vacation or your company lays you off. Having an emergency fund can prevent you from sinking into debt and tanking your credit score just to stay afloat.
An emergency fund is the safety net you fall back on when you’re faced with unexpected situations.
Having an emergency fund should be on your list of financial goals. And if you don’t currently have one, or you don’t know how to start one, that’s what this post is for.
How to start an emergency fund
Follow the steps below to learn how you can start an emergency saving today. So you’ll be able to handle any unexpected situations in the future.
1. Know how much you need to save
How much do you need to save as your emergency fund?
Please keep in mind that this money is not for your investments like I mentioned in my previous post, “How to Save When You Earn Minimum Wage“, where I mentioned that you should save for investments and starting a side hustle.
This emergency fund is for – as it is aptly named – emergencies.
Common sense says you should save at least six months of your paycheck. That is if you find yourself in the unfortunate situation where you’re let go from your work place.
This does not automatically mean you must have six times your paycheck. It means you should have six times the amount it takes for you to survive in a month.
If you have a family, save at least six times the amount it takes for you to maintain the household.
Look at your budget for the last month, or your monthly bank statement to figure out how much you’ll need to save as your emergency fund.
This does not include what you spend eating out or on clothes or on cable. Those things can be eliminated if you had to drop down to a bare-bones budget after a job loss.
It can feel intimidating to save six months of your monthly expenses. Even if you only consider you monthly essentials like food, clothing, transportation and rent.
Start by saving smaller amounts like $500 dollars and work from there until you eventually reach your goal.
But if you earn minimum wage, go to our post on saving when you earn minimum wage to know how you can save money when you earn minimum wage.
You’ll hear some financial experts, like Dave Ramsey, talk about having an emergency fund with just $1,000. (Ramsey’s famous money management plan — known as “baby steps” — does urge followers to save three to six months of living expenses, but not until after paying off all non-mortgage debt.) (1)
Keep in mind that your emergency fund is all about giving you peace of mind that you’d be able to weather an unexpected crisis.
Accredited financial counselor Kumiko Love told The Penny Hoarder she tried Dave Ramsey’s plan but didn’t stick to it because as a single mom she thought $1,000 wouldn’t be enough to get through a true emergency. (2)
Six months of expenses is a bit out there but this is to make sure you are absolutely covered.
The industry standard is three month. But what if you can’t find a new job after three months? You’ll have to start getting into debt to survive every month.
2. Find out where you’ll keep the money
Where will you keep your entire emergency fund? Should you keep it in the bank or have the cash in your home or your car? Let’s see.
It is important you keep your money in a place you can easily access in case of an emergency. Basically, keep your emergency fund liquid.
Don’t put your money in a savings where you will have to pay fees for withdrawing it in an emergency. For instance, a 401(k) account or a five-year certificate of deposit. Also, although investing your savings could help it grow, you don’t want to risk losing it.
I recommend you put your emergency fund in a no-risk account, like an FDIC-insured savings account or money market account.
Make sure you store your emergency fund in a place where you won’t be tempted to spend it.
Consider an online bank or a bank without a debit card if you feel you might be tempted to make withdrawals.
Putting your money in a credit account is another options but it won’t earn you much interest. But we’re not looking for interests here.
I highly recommend you have another account for saving the money you want to use to start a side business. This is the type of emergency fund where you’ll want to put it in an account where you wouldn’t mind the interest that comes with saving the money.
3. Find ways to add more money to your emergency fund
A mixture of regular saving amount and a dump of some large sums will work perfectly when starting an emergency fund.
Agree with your employer to send some percentage of your paycheck to your emergency fund, or you can set up your online banking to make automatic payments to your emergency fund every pay day. If the money is not in your main checking account, you won’t be tempted to spend it.
If your budget is tight, you can increase your income by starting a side hustle or working a second job.
You can also increase your emergency fund by putting any extra cash or windfall you get into your emergency fund. Sell items in your house you don’t use again and put the money in your emergency fund. Work bonuses and tax refunds should go into your emergency fund.
4. Know when to tap into your savings and when not to
When do you tap into your savings and emergency funds?
It’s not enough to know how to start an emergency fund, you should also know when you should dip into that emergency fund and when not to.
It can be tempting to see so much money in your account and not touch it. But avoid using that cash unless it’s a true emergency.
A good rule of thumb is to avoid spending your emergency fund on expenses that can be predicted. Emergencies like routine car maintenance, a large annual insurance bill or summer camp enrolment.
Keep in mind that once you’ve spent money from your emergency fund, be sure to replace it so you’re prepared for the next big thing that comes your way.
Have you started your own emergency fund?
If you haven’t, you should start immediately as it will also make your life a lot easier.
Imagine something happens and you have to start running around to borrow money from a bunch of people. I don’t know about you, but I don’t like borrowing and I especially like to have things planned out.
Manage Your Money Better
Below are some personal finance books I recommend to help you save more money. They have helped me a lot and I'm sure they'll help you in your journey to financial freedom.
- The Compound Effect by Darren Hardy
- Total Money Makeover by Dave Ramsey
- I Will Teach You to Be Rich by Ramit Sethi
- Master Your Money (Super Bundle)
- Need an extra $2,500? Get loans up to $5000
- Are you in debt? Get free debt consultation and find a solution to your debt
- Unshakable: Your financial freedom blueprint
- The New Money Masters
- Tools to make money in tough economic times
I have read about 5 out of the 7 books and I can boldly say they have helped me handle my finances better. I believe in them because they have helped me in my financial journey and I think they’ll help you too.