How to build an emergency fund on any income

An emergency fund is a crucial savings account for unexpected events. It's a financial safety net that helps you handle life's unpredictable emergencies without derailing your daily life.

Think of it as your go-to resource for things like a medical emergency, a car breakdown, or a sudden home repair. Having these funds gives you peace of mind and the breathing room to deal with the situation without panicking.

The most important rule is to leave your emergency fund untouched until an actual emergency happens. Deposit your money, let it earn a little interest, and resist the urge to spend it on anything else.

So, how much to have in an emergency fund? The general rule of thumb is to save enough to cover at least three to six months' worth of essential living expenses. This includes costs like rent or mortgage payments, groceries, utilities, and transportation.

Best short-term methods for building an emergency fund

In the short term, take small steps. Start by setting a reasonable goal. Plan to have an emergency fund of say $300 to $500.

That’s a goal that you can reach in a few weeks if you have a good income, and it can make a huge difference if you face an emergency.

With the goal set, the next step is to plot your moves to accomplish it. If you can save $30 to $50 a week, you can have a $300 to $500 emergency fund in just ten weeks. That becomes your overall scheme.

Plan a realistic savings program at first, both in the amount you can save each week and the overall amount. Make it a challenge, but not an unreachable number.

Here are some ideas for finding extra money each month:

• Reduce unnecessary spending: Look for small, regular expenses you can cut.
• Carpool: Save on gas and vehicle wear and tear by sharing rides.
• Shop for better insurance: Compare rates for both auto and homeowners insurance to find a better deal.
• Be mindful of utilities: Install a programmable thermostat to save on heating and cooling costs.
• Plan your shopping: Use a grocery list to avoid impulse buys.
• Limit entertainment: Plan just one special outing per month instead of several.
• Get a roommate: If you have space, a roommate can significantly reduce your housing costs.

As you find these savings, it's crucial to resist the urge to spend the money. Instead, be intentional with it. If you save more than $50 a week, consider directing that extra cash toward your emergency fund or retirement savings.

Making your savings automatic

Once you’ve trimmed $50 a week from your spending, you can set up an automatic savings plan to move that money straight out of your checking account and into the savings account you’re using for an emergency fund.

If you have online banking, it’s pretty easy. Set up an automatic plan to shift $50 a week into savings, and then forget about it.

Set up an online savings account

It's a good idea to set up an online savings account at a bank that's different than the one you normally do business with for your emergency fund.

Doing this lets you shop for good service and good rates, earn higher interest on your funds, and forces you to put the money in a place that’s not quite so easy to access.

If it's a savings account that's not linked to your checking account, you would have to authorize the transfer, which may take a day or two. You could even set up automatic deposit of your paychecks each month with a predetermined amount set for savings.

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Set a higher goal

Once the account you’ve established to save $50 a week has accumulated enough money, it'll start earning noticeable interest on its own. That’s the time to set another, higher goal -- maybe an emergency fund of $1,000.

Keep your automatic savings plan in place, but increase the amount. Once you reach that goal, aim for a single month’s worth of living expenses. Then two months. Then three. And just keep watching that emergency fund grow.

When you do have an emergency, the funds are there for you. Use them instead of putting an emergency repair or another unexpected bill on your credit card. There's no need to revert to plastic.

Building an emergency fund and other savings for the future

It's a smart idea to make your emergency fund a priority and to establish financially wise saving habits.

For emergency funds and savings in general, it's a good rule of thumb to set aside 15% of your annual income when you're in your 20s -- with 5% going into your emergency fund and 10% going to long-term savings.

As you age, increase the percentage of income you're saving, to 20% in your 30s, and to even more in your 40s. Every dollar you manage to set aside for saving limits your consumption by a dollar.

Also, don't reflexively spend unexpected money that comes your way. "Found money," or any money that’s outside your budget, should be put to good use in your emergency fund. Examples are tax refunds, bonuses, inheritances, and gifts.

To supplement your savings, consider your employer's tax-free retirement savings plans. Contribute as much as the non-taxable limits allow if possible, but certainly enough to qualify for the company's matching funds.

Another advantage to these plans is the allowance for participants to float a loan from their contributions in an emergency.

Long-term retirement

Alongside your emergency fund, let your long-term retirement savings accumulate and grow. In most retirement savings plans, investments are managed through the provider.

The younger you are, the more actively you'll want to invest, keeping in mind the risk-to-principal involved (risk-taking should diminish with age).

Remember, the more income you save instead of spending for consumption now, means the less income you'll have to replace after retirement.

The best way to make sure your savings grows is by controlling debt. And your prime target should be credit card debt because it's the most expensive.

Pay down credit accounts and aim at maintaining a maximum 30% credit utilization ratio. In other words, keep your card balances at or below 30% of the total credit limit.

Example: If your total credit line is $10,000, make sure you never owe more than $3,000 (and spread the same ratio over multiple accounts). Read up about your debt-to-income ratio and how it plays a factor in your financial stability.

Your emergency fund shouldn’t be touched -- until you actually need it. When you're sick or hurt. When you lose your job. When something indispensable needs a repair.

Thanks to your planning ahead, life has some financial stability.

Frequently asked questions

What are the three questions to ask before using emergency fund?

Before using your emergency fund, ask yourself these three questions: Is it a true emergency (unexpected and urgent, not a want)? Is it absolutely necessary (can the expense be delayed or covered another way)? And will I pay it back (will I replenish the fund as soon as possible)?

What is the 3-6-9 rule for emergency funds?

The 3-6-9 rule is a guideline for emergency fund savings, suggesting you save three, six, or nine months' worth of essential living expenses. The amount depends on your personal circumstances: three months for stable situations, six months for most people, and nine months for those with less stable income or a higher risk of job loss.

What are the three steps to building an emergency fund?

Building an emergency fund involves three steps: 1) Set a savings goal of three to six months of essential expenses. 2) Automate your savings with regular transfers to a separate account. 3) Choose the right account, such as a high-yield savings account, for safety and easy access.