How to Build an Emergency Fund

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by on August 28, 2013

Nobody – ever – has lived an entire life without at least one emergency. Whether the heater breaks on a frigid January day or you get four flats driving down a pothole-ridden road, you’ll need some extra savings to cover the bill. Yet, building an emergency fund is easier said than done, given ¾ of Americans live paycheck to paycheck. Fortunately, you don’t have to live on the financial edge on a daily basis. The following are some tips on building an emergency fund.

How Much Should You Save?

Experts typically recommend saving from three months to one year of living expenses in your emergency fund. The most commonly cited figure is six months. Six months of living expenses should give you ample time to find a new job or at least supplement your unemployment benefits until you do. And, it should cover most unexpected expenses while you’re working. If you need more than six months of living expenses to cover a bill, you should find a job with better health benefits or, in the case of a major repair, find a cheaper contractor! Factor in clothing, food, healthcare, housing, transportation, utilities and any other categories you couldn’t live without when determining how much to save.

Where Should You Save it?

Since emergencies are not planned, liquidity is of critical importance. You’ll need your money ASAP when one occurs. Also, you’ll want to protect the principal, so high-risk investments should be off limits. Checking and savings accounts are excellent on both fronts. They pay very low interest rates, but your principal will be guaranteed and you can withdraw money on demand.

How to Build Your Emergency Fund

Set a Monthly Goal

Set a monthly goal depending on your spare income and desired emergency fund. We suggest establishing an automatic savings plan as well, to ensure you follow through.

Save Your Tax Refund

The average federal tax return is over $2,800. That should cover a sizable chunk of your emergency fund. Consider having it deposited directly into a savings account to limit the temptation to spend it. Alternatively, you can adjust your W-4 to have fewer tax dollars withheld. After all, a tax refund essentially represents an interest-free loan you gave to Uncle Sam. Use this money to boost your emergency fund.

Keep a Piggy Bank

Every time you get home with change in your pocket, put it in a piggy bank, jar or another designated area. Doing so won’t singlehandedly build your emergency fund, but it’ll help.

Cut Back on Expenses

If money is tight and you can’t afford to spare any for savings, it’s time to cut back on expenses. Consider carpooling, dining at home, kicking expensive habits like lattes or smoking, or buying items second hand.

Generate Additional Income

If you’ve cut back and still can’t build an emergency fund, you’ll need to generate additional income by getting a second job or selling unnecessary possessions. Keep in mind the first option can be temporary, so you won’t have to deliver pizzas forever.

Assess and Adjust

Periodically assess and adjust your emergency fund according to changes in your financial situation.  For example, if you move from a small apartment to a four-bedroom house, your mortgage and utility bills will rise. You’ll obviously need a larger emergency fund in this situation.

Don’t Raid it!

Your emergency fund is for just that – an emergency. In other words, you shouldn’t “borrow” from it to fund a vacation or any other unnecessary expense. It’s only there to keep you afloat during a financial crisis.

Final Word

Building an emergency may seem intimidating at first. However, by following the mentioned tips, you’ll have a financial safety net in place to cover unexpected expenses. Just think of the alternatives – moving back in with you parents, meekly asking friends for money, or worse – and you should have ample motivation to create this vital financial cushion.

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