Expecting the Unexpected: How to Create an Emergency Fund

Editor’s note: In December we covered the importance of having an emergency fund and the potential long-term consequences of not having one. In this article we take a more in-depth look at how to create an emergency fund.

It’s inevitable: Life can hand you some expensive bumps in the road, and things can get pretty stressful if you don’t have the money in place to deal with them. According to a recent survey described by Forbes, 63 percent of Americans don't have enough savings to cover a $500 emergency. That means that over half of Americans don’t have a way to pay if their car breaks down or their pet needs an unexpected trip to the vet. It is essential to have some financial padding to help pay for the cost of unexpected events. An emergency fund can help you get ahead of these unpredictable life circumstances and cover the costs, without having to borrow or dip into the savings you’ve set aside for your goals.

What is an emergency fund?
An emergency fund is a sum of money—usually three to six months’ worth of expenses—that you’ve set aside to cover any sudden emergencies, like an accident, job loss, or home repair.

How do I get started in creating an emergency fund?
There are a few key steps to take in order to start your emergency fund:

Determine how much to save
The amount you save will depend on your income and expenses, so keep this in consideration when planning. Remember that a typical emergency fund includes approximately three to six months of your essential expenses. Essential expenses include things like housing (rent or mortgage), utility bills, food, and transportation.

Put it into your budget
Once you’ve established the total needed for your emergency fund, determine what will be a realistic amount for you to save each month in order to reach this goal. Put that amount into your monthly budget, and stick to it. It can help to have this amount automatically transferred into another account, like a savings account so you don’t have to remember to do it yourself each month.

Stick to it
You might be tempted to use your emergency stash for non-emergency items. One way to avoid this is to make accessing the money a bit more difficult. Don’t link your emergency fund to an easily accessible card. Keep a checkbook or separate card for access, and don’t carry it with you. This will eliminate the temptation to use these funds.

The do’s and don’ts of an emergency fund.

DON’T rush
Saving your emergency fund can be an intimidating thing to accomplish and does take time to build. Take it slow, and give yourself realistic savings expectations. It’s important to remember that putting aside even the smallest amount will help you move closer toward your savings goals.

DON’T cut into your 401(k)
The amount of money you set aside for emergencies should be determined after your 401(k) contribution. Your 401(k) is an essential part of your retirement savings. Reducing your 401(k) contribution might seem like an easy way to free up additional funds for emergencies, but it can have a big impact on your retirement nest egg, especially if your employer matches your contribution.

DO pay yourself first
Start off by paying on interest-bearing debts like credit cards or student loans, and contribute a smaller amount to your emergency fund. Over time—after you pay off these debts—you can increase your contribution in the amount of your monthly debt payoff as a reward to yourself, and your emergency fund.

DO find ways to cut spending habits
Consider reducing your costs in small ways, like daily spending habits. Perhaps you can get a simpler mobile phone plan or eat out less often. When you forego a few of these lifestyle luxuries, you can allocate that money to your emergency fund, helping it to grow faster over time.

DO make it accessible
Your emergency fund should be in an accessible place therefore you may not want to risk tying your emergency money up in a CD or investments. Explore accounts such as a Money Market Account (MMA) or a High Balance Savings account that could offer more interest than a typical savings account.

The information presented is for informational and educational purposes only. Content presented is not an investment recommendation or advice and should not be relied upon in making the decision to buy or sell a security or pursue a particular investment strategy.