Personal finance experts always recommend an emergency fund as a solid foundation for financial security. But what is an emergency fund and how can you build one? Another key question is, how much emergency fund should I have? In this post, I’ll break down exactly what having an emergency fund could mean for you, whether you should start one, how much you should save, and provide a step-by-step guide on how to save an emergency fund.
What is an emergency fund?
An emergency fund is essentially a savings pot with funds set aside for any emergencies that could arise in life. This cash is set aside just for emergencies. An emergency fund will allow you to pay for an unexpected expense that could otherwise potentially derail your financial plan. These kinds of expenses could include an issue with your car, an unexpected bill, or an emergency trip to the vet. It could be something like losing your job or having to pay a healthcare bill. This is of course, not a complete list, and there are any number of situations that could arise that you haven't budgeted for. Your emergency fund is designed for situations such as this.
An emergency fund is not for budgeted expenses or non-emergency expenses, that is, if you know you will have an expense coming up, then hopefully you will have already budgeted for it or you will have savings set aside for the purpose. If you do have to spend some or all of your emergency fund, then you can start saving towards it again. An emergency fund can give you peace of mind and a feeling of security that you would be able to afford to pay for an unexpected expense, if and when, it arises.
How can I build an emergency fund?
Most people agree that it is important to have cash set aside for emergencies and this is the essence of an emergency fund. But nevertheless, it can be hard to build one. So let’s go through, step by step, how you can build an emergency fund and answer the crucial question: how much emergency fund should I have?
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How To SAVE An Emergency FUND
Step 1: Make your goal manageable
Personal finance experts recommend you save an emergency fund of 3 to 6 months worth of expenses. You can work this out by looking at your monthly spending and multiplying this by 3 or 6, depending on how much you would like your emergency fund to cover. A 6-month emergency fund could be a solid choice, if you would like the peace of mind that you could cover your expenses for 6 months, in case something came up that meant you did not have any money coming in. Some people aim to save 12 months of expenses, whilst other people aim for 1 month. It is up to you what you set as your end goal for your emergency fund.
If you are starting from scratch though, reaching this end goal can seem like an impossible task. Saving 3 or 6 months of expenses may be your end goal, but why not start off small? This will make the goal more manageable. It can take a long time to build up savings, so aim for a smaller goal first. I recommend you set your first goal as $500 or $1000. This is a good number to work towards and it should give you enough to cover a car or housing repair.
Try to set aside a set amount each month to help you reach your goal. That way you will have the satisfaction of seeing your emergency fund go up gradually. It can help to add this to your budget so that you plan for it every month. See my simple budget tracker here.
Once you reach the first goal, you can set another higher goal and go from there. Before you know it, you will have a solid emergency fund.
Step 2: Open an “Emergency Fund” Savings Account
Now that you have a savings goal, be sure to open a separate account for those savings. You can even name it “Emergency Fund" in your online banking app. This should be a savings account that is easily accessible so that you could get the funds out in an emergency. It should be separate from your checking or current account and ideally, in a separate account from any other savings you may have or build up over time. It could even be with a different bank than your checking account so that you won’t see the money every time you log on to your bank account.
It is important to have your emergency fund in a separate account so that you don’t see the money on a daily basis and get tempted to dip into it. Also, if you open a high-interest savings account, then you will be earning interest on the money and you can have access to it if you need to.
Step 3: Pay yourself first
Make sure to set up automatic deposits to your emergency fund. As soon as your paycheck comes in, whether it is monthly, fortnightly, or weekly, make sure some money is automatically transferred to your emergency fund. That way, you don’t have to consciously think about it and the money will still end up in your emergency fund every month. It is easy to decide not to send the money one month or forget to send it another, so if you set up automatic transfers, then the money will leave your account before you notice it. Even if you can only afford to transfer a small amount, don’t worry, every little bit helps.
If you are also prioritising paying off debt, you should still try to build an emergency fund. This is because an emergency fund will give you a buffer against an unexpected expense that could come up, that would otherwise cause you to go into more debt.
Step 4: Channel extra money to your emergency fund
By now, you will hopefully have some money going into your emergency fund each month, but if you do have any extra money, it won’t hurt to add it to your emergency fund and reach your goal that much quicker. This extra money could be from cash gifts, tax refunds, or work bonuses. If you can only afford to put a little away each month, or can only add money now and then, then this would be a great way to give your emergency fund a boost. So next time you get a birthday gift, you could think about adding some of it to your emergency fund. Your future self will thank you!
Step 5: Boost YOUR income and cut YouR expenses
Another way to save even more for your emergency fund is to increase your income and reduce your expenses. You could cut down on your expenses by saving on groceries or other regular purchases, making a meal plan and meal prepping, doing free activities, and reviewing your subscriptions.
If you have already cut down your expenses as much as you can, then the only way to save more money is to increase your income. Consider how you might go about this. Perhaps you could pursue a promotion at work, take on a part-time job, or start a side hustle. There are numerous things you could do in your spare time, to increase your income.
Step 6: Only use your emergency fund in an emergency
This is the most important step! It may seem obvious that you should only use your emergency fund in an emergency, but it can be tempting to spend the money, especially if you are not used to having money saved up. Try to see the money as emergency money only, to be used only if your car breaks down or you need to fix something in your house, for example. Be strict with yourself and remember the money is not for holidays, clothes, or any other non-emergencies. Over time, you could build up another savings account for “fun money”, that could allow you to make these purchases. For the moment though, you should focus on building your emergency fund. It will give you peace of mind and a financial buffer, should you need it.
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