How and Why You Should Build an Emergency Savings Fund

Piggy bank in front of houseEstablishing and/or maintaining an emergency savings fund should be a top priority for every consumer. But unfortunately, it’s estimated that more than 60 million Americans don’t have adequate emergency savings in place. This is troubling, because unexpected financial setbacks–ranging from a job loss to car repairs to expensive medical bills–often push people into debt, particularly credit card debt.

Due to high interest rates, using credit when you don’t have the means to pay it off at the end of the month can make your purchases cost thousands more in interest and fees. Paying off surprise expenses with cash instead will save you significant stress and money, which will ease your immediate financial burdens and allow you to pursue your long-term goals. Let’s take a closer look at how to make a solid emergency fund so that you can breathe a little easier.

How Much Money Should You Have in an Emergency Fund?

As a rule of thumb, an emergency savings fund should include at least six months’ worth of living expenses. This amount ensures that you can stay afloat through a variety of hardships. It should give you enough time to replace income if you lose a job, manage time off from work due to an injury, and pay for most general large expenses that might arise. However, it probably sounds like a lofty goal, especially if you have very little savings in place currently. The important thing is to keep working toward it, and break up the goal into small attainable milestones (i.e. one month of expenses at a time). Take time to consciously celebrate these milestones, which may give you the motivational boost to keep saving.

One piece of good news is this data from a Pew study: “The median cost of households’ most expensive shocks was $2,000; the median household spent half a month of income on its most expensive one.” While it’s only a median, the $2,000 figure (and “half a month of income”) is likely a good bit lower than six months of expenses. Here’s the point: any savings is better than no savings. You absolutely should work toward the goal of six months’ worth of living expenses, but don’t let the loftiness of that goal keep you from pursuing it. Even a small amount of savings might be able to bail you out of an unexpected situation.

How to Set Up an Emergency Fund

The first thing you need to do is document your budget. It’s important that you know how much you are making and spending each month. You can use our calculator to get started, or choose from one of the many other popular online budgeting tools. You might even prefer pen and paper.

Making Budget Cuts

One you have this mapped out, you’ll be able to identify two things–how much you’re already saving each month (income minus expenses) and where there are opportunities to save even more. You’ll want to look for opportunities to make cuts in budget categories such as cable, hobbies, extra telephone lines, gifts, and perhaps charitable donations. After this exercise, ideally you will set aside 10 to 20 percent worth of your income into savings each month.

If you’ve done this exercise and don’t feel like you have much left to put toward savings, take a closer look at where most of your money is going. What’s keeping you from saving more? If monthly debt payments are a big part of the problem, it might be a good idea to work with a credit counselor. Our counselors can review your budget and credit with you and then make a plan for paying off your debt and building an emergency fund. If you opt for a debt management program, you may have your interest rates and monthly payments lowered, making your debt repayment much easier, while also providing an extra cushion to help establish emergency savings.

Setting Up the Bank Account

Once you have a good plan in place to save each month, you’ll want to turn your attention to the actual bank account. You’ll want your emergency fund to be separate from your main checking account (to limit the temptation of dipping into it unnecessarily), but you’ll also want it to be easily accessible in case an emergency does arise. It’s also important that the account has a manageable minimum balance/deposit requirement (if any) and that it offers unpenalized withdrawals. You’re probably fine with a basic checking account, which should be free or have the lowest fees possible.

Sticking to Your Plan

The last key to success is sticking to your plan. You’ve determined how much you can save, and you’ve set up a place to keep the savings. Now, you have to ensure the money goes from point A to point B. The key here is an expression you’ve likely heard before: Pay yourself first. There are a variety of ways (including tools and apps) to automate your savings. One popular strategy is to have your employer directly deposit your savings each pay period. However you go about it, be sure to treat your deposits just like any other household bill. Make your savings non-negotiable, and stick to your schedule.

Emergency Savings Builds Momentum

Once your emergency savings fund has been established and you have met your savings goals, you’ll likely feel relieved in knowing that you have enough funds to bail yourself out in a time of need. However, it is important to constantly reevaluate your budget and needs, and adjust your savings goals accordingly.

The good news is that if you successfully build an emergency fund, you will have done so much more than that–You will have developed a habit! Once you’re in the habit of saving, you’ll be able to take that extra money each month and pay down debt, save for retirement, start a college fund, prepare to buy a home, or pursue a number of other financial goals. Just remember to always keep this emergency cushion in place. You never know when you’re going to need it.

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