4 Steps to Building Your Emergency Fund
by Maurie Backman | Updated Sept. 16, 2021 - First published on March 7, 2019
We all need savings for life's many financial surprises. Here's how to build them up.
Life has a way of hitting us with unplanned expenses. You never know when your car might break down, your roof might spring a leak, or an injury might land you in the hospital with a whopping bill to boot.
That's why it's crucial to have an emergency fund -- ideally, one with three to six months' worth of living expenses in it. Then you'll have savings to tap if you incur a major expense or find yourself out of a job -- and a paycheck.
Building an emergency fund isn't something most of us can do overnight. But if you currently lack that safety net, you should make it a priority so you can avoid racking up costly debt the next time a surprise bill lands in your lap.
Here are four steps to building your savings -- and getting the peace of mind that comes with having money in the bank.
1. Create a budget
It's hard to save money when you have no idea where yours is going. One of the most important steps on the road to building savings is having a monthly budget to follow. To create yours, simply list your recurring monthly expenses, factor in once-a-year expenses (like annual membership fees), and compare your total spending to your total take-home pay. This will give you a sense of how much money you might manage to save on a monthly (and annual) basis. You can compile a list of your different expenses by searching through your bank and credit card statements. For those once-a-year expenses, allocate 1/12 of the amount to each month's spending. For example, if you pay a $300 annual fee to maintain a license, allocate $25 per month for that cost.
Now let's imagine you currently spend $4,000 a month and bring home $4,300 monthly after taxes. This means you have an opportunity to bank up to $300 a month without changing your income or your spending. Now, $300 isn't bad, but if you're starting with little to nothing in emergency savings, you'll want to do much better, which leads to our next step.
2. Cut back on expenses
We all spend money on both needs and wants. But if you're behind on emergency savings, you'll need to start seriously cutting back on the latter until you're in a more secure place financially. Once you have your budget in place, figure out which non-essential expenses are costing you the most, and select a few to cut. That could mean canceling your cable plan, pledging to walk rather than springing for rideshares, or cooking at home instead of spending a small fortune on takeout.
There's another option, too: If you don't want to deprive yourself of the luxuries you've come to enjoy, try replacing one of your needs with a lower-cost alternative. Take housing, for instance. Moving to a smaller home or apartment in a cheaper area could reduce your mortgage or rent payment by several hundred dollars a month, freeing up that cash to save.
Transportation is another major expense for most workers. If your vehicle is brand-new, high-maintenance, and/or fuel-inefficient, then swap it out for a reliable used car with good gas mileage. This could save you hundred of dollars per year in fuel, maintenance, car payments, and insurance.
The point, in any case, is to cut back meaningfully on expenses until your emergency savings are fully funded.
3. Bank any bonus cash you receive
If you're lucky, you may get the occasional windfall during the year. It may be a raise at work, a performance bonus, or a tax refund from your friends at the IRS. Either way, the first thing you should do with that cash is stick it directly into your savings account before spending a dime. Since it's money you weren't already using to pay your living expenses, there's no excuse not to bank it all.
4. Get a side hustle
Maybe your paycheck isn't as generous as you'd like it to be, and despite your best efforts to cut back on spending, you're just not building up your emergency fund as fast as you'd like. Enter the side hustle. The beauty of having a second gig is that the money you collect from it won't already be earmarked for other expenses.
Having a second gig might also help you preserve your emergency fund once you complete it. If you lose your day job, you'll have the option to ramp up on that side work while you look for a new full-time role, thereby reducing your need to withdraw from your savings in the meantime. If you find a second job you enjoy -- whether it's dog-walking, crafting, consulting, or driving people around -- it won't even feel much like work.
Emergency Fund Calculator
Now that you know the four steps to building an emergency fund, use our six-month emergency fund calculator to see how much you should try to save for an emergency.
Don't take chances
Having no emergency savings means living on the edge financially, and that's not something any of us can afford to do. Take these steps to build your emergency fund, and with any luck, you'll soon be sitting on a pile of cash that's there for you when you need it.
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