Everyone needs to save for the unexpected. When you have nothing in reserve, anything unexpected becomes an emergency that has to go on a credit card.
It could be a job loss or medical bill — or something as small as a car repair or a lost phone. A financial buffer can keep you afloat in a time of need and let you recover without going into debt. That’s why an emergency fund is more important when you’re barely scraping by, rather than later on, when you might have more savings, better credit, home equity or a higher income.
“One of the first steps in climbing out of debt is to give yourself a way to not go further into debt,” says Liz Weston, NerdWallet columnist.
To build an emergency fund, consider these questions.
How big should my emergency fund be?
The exact answer to this depends on your financial circumstances and how much insurance you have, but a good rule of thumb is to have enough to cover three to six months’ worth of living expenses. This can give you enough time, for instance, to find a new job or supplement your unemployment benefits until you do.
But anything in the bank is better than nothing — and $500 will get you out of many scrapes that would otherwise put you in the hole.
Start small, Weston says, but start.
Where do I put my emergency fund?
Since an emergency can strike at any time, having quick access to your cash is crucial. Consider a savings account, since the money will be safe and you’ll be able to withdraw it without hassle. This should be a separate account from one you use daily so you’re not tempted to dip into your reserves.
What steps do I take to start an emergency fund?
- Set a monthly savings goal. This will get you into the habit of saving regularly and will make the task less daunting. Contributing a small percentage from each paycheck, for instance, is one way to do this.
- Keep the change. When you get $1 and $5 bills after breaking a $20, drop some in a jar at home. When the jar fills up, move it into your savings account.
- Tidy up your checking account. If there’s money left at the end of a pay period, move some into your emergency fund.
- Save your tax refund. The average refund is in the thousands, which can give a good boost to your emergency savings. (See “9 Smart Ways to Spend Your Tax Refund.”) When you file your taxes, consider having your refund directly deposited into your emergency account. Alternatively, adjust your W-4 tax form so that you have less money withheld, and direct the extra into your emergency fund.
- Cut back on costs. If you’re falling short on saving, see which parts of your monthly spending you can trim. Some ways to do this include carpooling, cooking meals at home, saving leftovers and avoiding small daily purchases like takeout coffee. Put the money in your emergency fund as you “save” it.
- Get supplemental income. If you have the time and willpower, get a second job or sell unused items at home to accumulate more money for your fund. (See “12 Ways to Find Fast Cash, More Savings.”)
- Assess and adjust contributions. Check in after a few months to see how much you’re saving, and adjust if you need to put in more. This is especially important if you go through a major life event such as marriage or a move to a new city.
An emergency fund is for emergencies
What’s an emergency? Something that affects your health or ability to earn money.
What’s not an emergency?
- Holidays, birthdays and mental pick-me-ups for yourself or significant others.
- A car repair if you can hitch a ride or take the bus.
- A great deal on something you don’t need.
- Expenses that aren’t surprises, like car insurance.
Draw a line between savings for emergencies and savings for anything else. In fact, once you’ve hit a reasonable threshold of emergency savings, Weston says, it’s a good idea to begin another account for irregular but inevitable items such as car maintenance, vacations and clothing.
This post updated Feb. 26, 2016. It originally published Aug. 28, 2013.
Image via iStock.