7 Steps to Starting an Emergency Fund

Written by Tonya Chin. Posted in Personal Finance

7 Steps to Starting an Emergency Fund

Financial disasters can come out of nowhere. Whether it’s job loss, car repairs, medical bills or any other unexpected situation that requires a large amount of money—there are some things you just can’t plan for. Start an emergency fund and make sure you’re always prepared for the unexpected. Here are a few tips to get started.

Decide What Kind of Fund You Need

The purpose of an emergency fund is to hold money that you may need for some kind of financial emergency in the future. However, there are two types of emergencies you should consider. The first type includes short-term or immediate emergencies, like getting into a car accident or replacing appliances in your home that break. This short-term fund should include cash or other very liquid investments that you can quickly access during an immediate emergency.

If you would like to invest your emergency fund so that it grows instead of just sitting around unused, you should create a second fund that is for large-scale emergencies. This might include a job loss or recovering from a major natural disaster. You can invest your fund and earn a slightly higher level of interest, but that also means that it may take a few days longer to liquidate when you need it. Just make sure that you have a short-term emergency fund to cover you until you can access those funds.

Determine How Much You Need in Your Fund

Different people have different ideas of how much they should keep in their emergency fund. Some may set the goal of having $1,000 in their fund, others may decide they need three to six month’s living expenses, or even a whole year’s worth of wages. There’s no wrong amount to keep in your emergency fund. It all depends on what’s right for you. Decide how much money you need in order to feel secure, and make the amount your goal to keep in your emergency fund.

Create Monthly Goals

One common reason to keep an emergency fund is in case you suddenly lose your job. If this is why you’d like to start a fund, you’ll probably want to keep a few months’ worth of living expenses in your fund. In order to accomplish this, you should first make a list of all of your necessary monthly expenses, including food, housing costs, utilities, loan payments, transportation costs and any other bills you have to pay. If you’d like, you can add in an extra amount for other, less necessary items, like clothes, shopping and other activities you might enjoy. Total your monthly expenses and multiply that amount by the number of months you would like to save for. For example, if you need to cover $2,000 in monthly expenses for four months, you will need to set aside $8,000 in your emergency fund.

Whether it’s based on monthly living expenses, yearly income or anywhere in between, determine the amount you’d like to save. Now, create weekly, monthly or some other timely goals for your fund. Determine how much money you can comfortably part with each month, and set that as your goal to contribute to your fund. Even $10 a month will help, so don’t worry if that’s all you can part with. Having something in your fund is better than nothing. If you can, contribute more than the goals you set in order to fill your fund faster.

Put It in an Account That Works for You

Once you have come up with your goals and your plan to achieve those goals, it’s time to set up an account. While you could just keep your emergency fund with your other money, it’s usually a good idea to have a separate account to reduce the temptation to spend it on other things. In addition, since you aren’t planning to withdraw money from your fund unless an emergency arises, you can invest your fund in order to make some extra money. Generally, you’ll want your emergency fund to be in an account to be fairly accessible, liquid and low-risk. A savings account is the most liquid account that can also earn you a very small return. You can also put your money in a money market account or short-term certificates of deposit.

Make it Automatic

If you know how much you can contribute to your emergency fund each month and you feel comfortable parting with that money on a regular basis, set up an automatic withdrawal from your checking account to your emergency fund. This will make sure that you are meeting your goals and it also makes it easier on you so you don’t have to remember to make a deposit each month. You can also readjust the amount of the automatic deposit if you find you cannot afford the amount or if you can afford to contribute more.

Don’t Stop When You Reach Your Goal

Just because you set specific goals doesn’t mean you have to stop contributing to your emergency fund when you reach them. The more you have saved for in an emergency, the better. You never know how severe the emergency, or how many emergencies you might encounter. Think of the goal you set as a minimum.

Know When to Spend It

So now that you’ve set up an emergency fund, when is it the right time to spend it? A pair of shoes that you see on sale for one day only is not an emergency. Purchasing a new big screen TV isn’t an emergency, even if your old TV breaks down. A true emergency situation is one that requires some kind of immediate financial action and also affects your well-being or can impact the functionality of an important asset, like your home. Some examples include a large deductible or co-pay for a health emergency, the failure of an important appliance, like a furnace or heater, the need to travel or make arrangements for a family emergency, such as a funeral, or major and unexpected car repairs. Before dipping into your emergency fund, you should ask yourself two questions: Does this situation require immediate attention or can I take my time and save some money to pay for it? And, does this situation have a direct impact on my well-being, my family’s well-being, or an important asset that I rely on?

Even if you can only contribute a little bit of money, start your fund as soon as possible. An emergency fund can be a real lifesaver in times of need. Not only does it provide a financial cushion for situations you can’t foresee, it also provides piece of mind in knowing that you can handle anything that comes your way.

Sources

 

Tonya Chin

Tonya Chin

Tonya Chin is a financial writer based in Los Angeles. She received her bachelor’s degree in journalism from the University of North Carolina at Chapel Hill and has three years’ experience writing about fixed income securities. When she’s not writing about finance, she enjoys practicing yoga and playing the piano.

Leave a comment

Unable to load the Are You a Human PlayThru™. Please contact the site owner to report the problem.

Editor's Picks

  • retire-early-1

    Proven Ways To Retire Early

    Early retirement is part of the American Dream and it might mean very different things to different people. Millennial entrepreneurs might hope to sell their companies.

    read more

  • Icon 01

    Pros & Cons of Reverse Mortgages

    The reverse mortgage is one of a number of financial tools the aging can use to gain access to the equity in their homes without selling them. That is, it allows them to remain in their home which.

    read more

  • Icon 01

    Tips For Investing In Real Estate

    One of the hottest investing strategies in recent years has been real estate. Many people are capitalizing on affordable real estate prices and building up a great savings for their retirement.

    read more