The material presented here is for educational purposes only, and is not intended to be used as financial, investment, or legal advice.
5 Steps to Build an Emergency Fund
Most Americans don’t have an emergency fund — and even if they do have money in savings, it may not be enough. Only 39% of Americans have enough savings to cover a $1,000 emergency; yet in 2018, 34% of U.S. households experienced a major unexpected expense, CNBC reports.
Nearly a quarter of Americans say they would pay for an unexpected car repair or medical expense with a credit card or personal loan. Unfortunately, both of these options come with interest payments. That's why it’s a good idea to build up an emergency fund before a crisis arises. You can pay for whatever happens, interest-free, without accumulating more debt. Financial experts actually recommend that you grow your emergency fund first — before paying off debt — since an emergency can happen at any time and may debilitate your finances.
No matter what state your financial health is currently in, you can start building an emergency fund. Here's how:
Step 1: Evaluate Your Current Situation
If you aren't already keeping track of your spending habits, now is the time to start! According to The New York Times, relying on credit cards and shopping online can increase your spending by up to 10%. High credit limits and the ease of digital payments make people less likely to think about how much they're spending.
Even if you use online banking or a digital finance tool, try keeping track of your finances with pen and paper for at least one month. Don’t forget to record every:
- Purchase you make
- Bill you pay
- Income source you have
Use columns to see how much you're spending versus how much you're earning. Also note vital expenses — such as rent or groceries — versus extraneous expenses, like dining out or going to concerts. Now you have an idea of where your money is actually going, and you can see where you could trim expenses to save more.
Step 2: Set Your Goal
Decide how much you would like to have in your emergency fund before you begin to build it. The good news? Having just $1,000 set aside puts you far ahead of the average American.
The savings “sweet spot,” according to experts, is having at least three to six months' income saved in case of a job loss. Why so much? The average job search takes at least three months — and higher positions, such as C-level jobs, can take up to six months, according to Time.
Certified financial planners typically recommend saving at least 10% from every paycheck. If these figures seem daunting, know that saving even just a few more dollars a day can add up quickly! And if you are married or have a partner, you can build up an emergency fund together, as a team.
The earlier you start saving, the better. Having even a small amount in your emergency fund puts you at an advantage should the unexpected happen.
Step 3: Plan Ways to Save More Money
Once you have a clear picture of your current financial state, spending habits and savings goals, you can work on implementing savings techniques. Here are some ideas:
Curb Your Current Spending Habits
Use your one-month audit to identify spending patterns and think about how to improve them. If you purchase coffee daily, save money by making it at home. Cook meals at home rather than eating out, and look for free or inexpensive local events to replace pricey concerts, movies or shows.
Create a Budget and Keep Tracking
Use a free budgeting tool — such as Mint® — to automatically track your finances, organize your spending and savings goals, and diligently keep track of your spending habits. Another option is using free budget worksheet templates.
Make your emergency fund savings grow by putting money in an interest-bearing account. There are a variety of savings accounts to consider, including money market accounts that provide higher dividends as long as the minimum balance is met.
A savings certificate provides a fixed annual percentage yield (APY), but restricts when the deposit may be withdrawn. One benefit of a certificate is that the dividends earned are typically higher than that earned with other savings accounts. If you’re unsure which type of account would work best for your situation, ask a financial planner for recommendations.
Step 4: Visualize Your Goal
Creating visual cues for saving can actually help you save more. According to neuroscience research reported by LearnVest, people make better financial choices when they imagine the future they want.
Try saving cash in a money jar so that you have a visual representation of how your savings are increasing. If you need extra inspiration, affix a picture of a financial goal — your dream house, a beautiful travel destination or a designer outfit you have your eye on, for example — on your savings jar to keep you inspired. You may be saving toward your emergency fund, but a photo of something you desire reminds you that you’re more likely to reach your life goals if your emergency needs are covered.
Step 5: Rebuild When Needed
Once you use part or all of your emergency fund, repeat steps one through four again until you replenish it. Regularly save a portion of your income toward your new emergency fund goal. Cut expenses where you can, and save more if possible.
No matter what state your finances are in, always look out for your future by making saving a top priority. You'll be less likely to go into debt, and your healthy financial practices will enable you to do more of the things you love.
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