How to Build an Emergency Fund (Step-By-Step Guide)

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Kumiko Ehrmantraut

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Kumiko Ehrmantraut

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• The ONLY 3 Reasons to Touch Your Investments - February 18, 2021

For me, one of the most important categories in my budget is my emergency savings. Without it, I would have never been able to get out of debt.

No matter how much we don't want to admit it, we can't control everything. Life happens, and so does the unexpected. Without an emergency fund, you are more likely to fall further into debt.

Things like a job loss, car repair, medical costs, or even a lost phone can cause your financial life to spiral out of control. During these times of need, you need to have something that you can rely on without going further into debt.

If you already have debt, there is no better way to start climbing out of the hole than having a system in place that prevents you from carrying more debt. That's why having an emergency fund is so important, especially if you are barely making ends meet.

When I started saving, I had little income and a ton of credit card debt, but I made my emergency fund a priority and you should too.

STEP #1: SET A SAVINGS GOAL

If you type into Google “How much should I have in my savings account?” you are probably going to read a couple of different answers. The truth is, there is no right answer. How much you decide to save in your emergency fund is completely up to you and your particular circumstances, but here is what I recommend.

If you have nothing saved, I recommend starting with a goal of $1,000. This should be the minimum amount in your emergency fund . I use the $1,000 rule for my emergency fund, and I have always felt comfortable with it.

What it comes down to is this – choose an amount that makes you feel comfortable. If you can go to sleep comfortably at night knowing you don't have to worry about money, then use $1,000. If you feel like you need more to feel comfortable, increase the amount to $1,500. If you set your emergency fund goal based on someone else's recommendation, you might feel like giving up before you have even begun. $500, $1,000, $2,000, it doesn't matter. Something is always better than nothing.

STEP #2: CHOOSE THE RIGHT SAVINGS ACCOUNT

When deciding on which savings account to open, I do recommend an online savings account and here is why:

• You can transfer as little or as much as you want into your free Savings Account. Transferring $5 to your new savings account is just as easy as moving $5,000. Trust me; I know from experience.

• Opening an online-only savings account makes it a little more inconvenient to use. It usually takes 2-3 business days to transfer money from your online-only savings account to your regular checking account at the bank. It's always a better idea to open a savings account at a different institution than your regular checking account. If you don't, and are not in the habit of saving, you could easily use your regular debit card to access your emergency funds.

• Most are free to open and have no fees.

I highly recommend Ally Bank for online-only savings accounts. They are now offering 0.50% annual percentage yield (which is higher than most savings accounts), there are no monthly maintenance fees, and you can open as many as you want. You can read all about their online savings accounts here.

If you decide that an online savings account is not right for you, that is totally OK. If you want to open one at your local credit union or bank, here are some things you should look out for:

• Try to open one at a different institution than your regular checking account.

• Make sure it's FDIC-insured. FDIC stands for “The Federal Deposit Insurance Corporation.” This is a United States government corporation, and it provides deposit insurance. FDIC-insured guarantees the safety of your deposit at member banks – currently up to $250,000 per depositor per bank.

• It doesn't have a minimum balance requirement.

• It has no fees.

• It offers the highest interest rate available to you. Try comparing different interest rates when searching for a savings account.

• ALWAYS check to make sure that it does not produce a hard inquiry BEFORE you apply. A hard inquiry can stay on your credit report for up to 2 years and can negatively impact your credit score anywhere from 6-12 months. Make sure you ask before applying.

STEP #3: AUTOMATE YOUR SAVINGS

Look at your budget and decide on how much you can afford to set aside. Choose a day during the month to automatically move money from your checking account to your savings account.

If there is any advice I can give you, it would be to automate your savings. Automation has helped me tremendously for my emergency fund, and I am currently saving $630 every month without even having to think about it.

Not only does it get you into the habit of saving regularly, but it will also make saving less dreadful. You may have a goal to save $1,000 for your emergency fund, but the amount that you save every month can be small. Remember, something is better than nothing. I started with $25 every month, but it gave me peace of mind that I was taking action and working towards something.

By removing yourself from the equation, you are ultimately saving yourself from you. Trust me; you're going to start off strong with determination and the best of intentions, but it's so easy to get distracted and not follow through. By automating your savings, you are setting up a plan that will lead you to success.

STEP #4: SAVE MORE

Remember in Step #3 where I told you to look at your budget and decide how much you want to save every month? Take that number and increase it by 10%. For example, if you planned on saving $30 every month, try increasing your savings transfer to $33. I want you to try this after six months of saving. Start with your initial amount from step #3, and then increase it by 10% after six months. Always push yourself to save more.

Increasing your savings might seem scary as hell at first, especially if your initial saving amount was quite large in step #3, but after a few months, it won't feel as daunting. After a few months, if you feel like it's too much, scale it down a bit. Remember, it's all about being comfortable. You don't want to push yourself so hard you feel like giving up. Slow and steady wins this race.

Step #5: SAVE ENOUGH TO COVER 6 MONTHS OF LIVING EXPENSES

After you hit your goal amount, keep saving until you can cover six months of living expenses. I know that might seem like an unreachable goal, but I promise you that it's not. The whole point of an emergency fund is to take care of you and loved ones if something goes wrong. Being laid off, being sick for an extended period of time, or even a death in the family is something I would never wish upon anyone, but it happens. Being financially prepared will allow you to worry about the things that matter and not about how you are going to make your next payment.

If you haven't already, I challenge you to sit down and start planning for emergencies. Use these steps to create a savings plan today.

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