An emergency fund is the term given to your savings account that acts as a resource to provide you with income during emergencies. Over time, you are building an emergency fund to get it to the amount that you need to live off of should an emergency arise. Emergencies include needing a new hot water heater, paying the deductible on your automobile policy after an accident, etc.
Emergency funds are also used to allow you to meet your monthly obligations (pay your bills) should you lose your job. Therefore, building an emergency fund up is essential in order to cover these situations. In an ideal world, you will never touch your emergency fund. However, the world is far from ideal.
Building An Emergency Fund
What Should The Size of Your Emergency Fund Be?
Many financial experts recommend building an emergency fund to 3-6 months worth of your monthly expenses. So if your monthly expenses are roughly $2,000 per month, your emergency fund should contain between $6,000 and $12,000. I feel that this amount is too conservative. The reason is because if you lose your job, there is a chance you will not find a replacement in 3-6 months. What happens in months 7, 8 or 9? Where is the money coming from? Many will resort to using their credit cards to get by. This is a bad idea. By doing this, you are creating more headaches down the road.
To avoid this, I recommend building an emergency fund to 6-12 months of your living expenses. Using our hypothetical $2,000 expenses per month figure above, this means you need between $12,000 and $24,000 in an emergency fund. I realize this amount seems high. But you will be grateful when you have it saved. You will have peace of mind that should the unthinkable happen, you are in good shape for a year.
Where should you invest your emergency fund? Ideally, you want your emergency cash in liquid accounts, such as savings accounts and bank certificates of deposit (CD’s). Even if you do have some of your emergency fund in CD’s, there should still be a decent amount (at least $1,000) in cash. This way you can quickly access it, whereas with CD’s you have to go to the bank and pull the money out. This process will add at least a day or two until you have access to your cash.
How To Build An Emergency Fund Size
Now, you may be thinking how do I go about building an emergency fund to one year’s worth of expenses? There are numerous ways to build up your emergency fund. Before I mention the ways, I want to point out that I am not telling you to completely change your way of life just to build up your emergency fund. Keep living your life. Just cut back a little here and there. The money will add up. Here are a handful of ways for building an emergency fund:
Create a Budget:
If you don’t have a budget, you need to create one. Doing so will allow you to see where you are spending your money and will help you spend it smartly. I know what many of you are thinking: the idea of creating a budget sounds painful. It really isn’t. I use Power Wallet. It’s a free tool that you can access online and on the go. Once you create a free account, you link your bank and categorize a few things and you are done. Then you only have to log in to the account to see how you are spending your money. (If you prefer a more “hands on” approach, a free excel spreadsheet might be the way to go.)
Revise Your Budget:
If you are spending $150 month dining out, cut it back to $100-125 and set up an auto transfer to your emergency fund for the $25-50. Here are 8 tips to save money when dining out. (Yearly Savings: $300-$600)
Transfer Savings to Savings:
When you go shopping, look at the bottom of your receipt. Most likely there will be listed the amount you saved. Take that “savings” and transfer it to your emergency fund. I only do this for my grocery shopping and transfer a healthy bit of money over the course of a year. (Yearly Savings: $1,000)
Save a Portion of Your Tax Refund:
If you get a tax refund each year, take a set percentage of it and transfer it to your emergency fund. Since most look at a tax refund as “extra money”, you should be saving a healthy portion of it and using a small portion for spending. This assumes you have all of your high interest debts paid off. (Yearly Savings: $400 – this assumes the average refund and you are still paying down credit card debt.)
If you get a raise, ignore it. Take out your last paycheck prior to the raise and compare it to your new paycheck. Find the difference and set up a transfer to move that amount from your checking account to your emergency fund each time you get paid. You’ve been living off your old salary, so you can do it for a little while longer. (Yearly Savings: $1,000)
Save Your Change:
You should be paying for most everything in cash. When you come home from a shopping trip, take all of your loose change from your pocket and put it in a jar. Each month, take the jar, count the coins, and deposit that amount into your emergency fund. Note: Many banks offer free coin counting. Under no circumstance should you pay to have your coins counted! (Yearly Savings: $225)
Just these 6 tips will net you over $3,000 in your emergency fund in one year. This would be on top of what you are saving monthly. And, these are only 6 tips! In my eBook, Spare Change, I list hundreds of other ways to boost your emergency fund savings.
Readers, how did you go about building an emergency fund?