A good emergency fund is one of the foundations of a great financial life. In addition to providing a safety net and sense of security, emergency funds can actually help you build wealth by preventing you from taking on expensive debt by borrowing money. So how do you go about building one, especially if it feels like you’re already short on cash?
There are three main strategies you can use:
- The “go crazy” emergency fund method
- The “take advantage of windfalls” to build an emergency fund method
- Percentage-based emergency savings
Before I get into the strategies in detail though, let’s talk about how much of an emergency fund you should have on hand. Basically, it depends on where you’re at financially already.
How big of a fund to have
If you don’t have an emergency fund at all or are deeply in debt, start out small. A thousand dollars is a good starting point. If $1000 seems impossible at first (and I’ve been there) start with whatever amount you think would work for your situation. Eventually, you’ll want to build up your emergency savings to anywhere from 3-12 months’ worth of expenses.
Advice from experts vary, with Suze Orman recommending 8 months of emergency savings, Dave Ramsey recommending 3-6 months once you’re debt free but the house, and Mary Hunt recommending a contingency fund with either $10,000 or 3 months’ worth of expenses. Personally, I err on the side of 12+ months, because I’ve experienced long term unemployment in the past.
The “go crazy” emergency fund method
If you’re living paycheck to paycheck or having difficulty getting an emergency fund started, this method is probably best for you. It amounts to making building up your emergency fund the priority for a very short period — say, a week or two. During that time, you go crazy doing everything you can think of to make extra money to put toward the fund. Babysit, walk dogs, rake leaves, have a garage sale, tutor kids, sell a toy, sell your DVDs on eBay, working overtime — whatever you can think of.
Then put every dime toward your emergency fund. You’ll only be doing it for a week or two, so resist the temptation to “reward” yourself by spending money because you’ve been working so hard. Your reward will be a nice little start on your emergency fund, and the sense of accomplishment that comes from doing something that will help you in the long run.
The “take advantage of windfalls” to build an emergency fund method
This one’s pretty self-explanatory. Getting a tax refund? Great! Use it to start your emergency fund (and then make sure you’re having the correct amount withheld from your paycheck.) You can use bonuses, inheritances, and gifts to start your e-fund too. The important part is to put the unexpected money to good use in an emergency fund instead of being tempted to spend it because it’s found money, or money that’s outside your budget.
Percentage-based emergency savings
This method works best once you’ve gotten a small emergency fund started, and you feel pretty in control of most of your financial life. As you might guess, percentage-based emergency savings means that you decide on a certain percent of your check to send to your fund each time you get paid. Then you send that money first, and don’t touch it except in the case of an actual emergency. If you get a raise, you can just increase the percentage to build your fund faster — and then use the money for retirement or other goals once your emergency fund is where you want to to be.
No matter which method you choose (or methods, since you can always combine them), remember that the important thing is to start saving something for emergencies, and to replenish the fund if you need to use it.Posted in Emergency Funds on 02.24.11 with 12 comments.