A 7 Step Formula To Building A Rock-Solid Emergency Fund
Updated: Nov 18, 2021
A fully-stocked emergency fund can be your best friend in an unexpected situation. It's easy to get into debt if you don't have sufficient savings, and when you find yourself in a tough spot, you might even take out more loans or borrow money from friends and family members. In a perfect world, we would always have enough money to cover emergencies as they come along, but the reality is that very few of us do.
In fact, according to Bankrate's July 2021 Emergency Savings Survey, more than half of Americans (or 51 percent) have less than three months' worth of expenses covered in an emergency fund. This total also includes 1 in 4 Americans (or 25 percent) who indicate having no emergency fund at all — up from 21 percent in 2020. Protecting yourself from a rainy day is crucial in these uncertain economic times. However, it can be challenging to find a few extra dollars to save. Progress is often not achieved in giant leaps; instead, it's taking a couple of steps forward. Let's take a look at this 7 step formula to building a rock-solid emergency fund.
1. How much do you need for your emergency fund?
The best way to figure this number out is to reverse engineer it. First, how much money do you make? Then calculate your yearly salary along with your monthly salary. From there, subtract this number from your total monthly cash needs. This is how much you'll need to save each month. The general guideline is to have two sets of emergency funds.
Strive to build up to three months' worth of living expenses in your emergency fund as soon as possible, but don't feel bad if this process takes several months or even years. Time is on your side because compound interest works in your favor the longer you save. Then you want to build enough in your emergency fund for those long-term expenses if you lose your job or have a medical emergency.
"The best way to build your emergency fund is to start with an amount that's realistic for you," says John Ulzheimer, president of consumer education at SmartCredit.com. "Focus on the three-month mark." That way, you can increase it over time.
2. Calculate the exact amount of time it will take you to reach your goal.
Calculating the amount of time that it'll take you to save for your emergency fund will allow you to set realistic goals. Without knowing how long it will take you, it will have you shooting in the dark, and you might find yourself dipping into your emergency fund. But if you can see the goal, for instance, if you know it will only take you a year, it'll encourage you to make the necessary short-term sacrifices. Creating an emergency fund requires discipline and making it a priority. Without prioritizing, it'll fall to the wayside, and you'll never fully fund your emergency fund.
3. Set up a dedicated savings emergency account.
The first step is to set up a dedicated savings account at your bank and fund it regularly. Your goal is to build up this fund without draining any other accounts. Ensure that it's a high yield savings account so you can reap the benefits of compound interest. You might think you can do this with an existing savings account, but it's much better to separate this process so you don't blend your funds or dip into them. Next, you want to make this account easy to fund but hard to reach. Whether the account is solely online and separated from your original accounts or in a smaller local bank that you would have to drive to access. This will help to reinforce the idea that this money is off-limits.
4. Funding your emergency fund with little cash.
If you don't have a lot of extra cash, cut back on the extras—lower your streaming or cable expenses, eliminate dining out, reduce your cell phone bill, and eliminate (or reduce) any subscriptions that you could live without for one year. If you have credit card debts give them a call and see what you can work out with them to give you room to save. Where can you save more money and find some hidden cash? Remember, you don't have to start with a lot of money to fund an emergency fund. You simply have to be patient and disciplined. You can deposit 1-3% of your income every pay period or save $10 or $20 a week to start. You can always increase the percentages or the dollar amount at a later time.
Do you have to get a temporary side hustle to fund your emergency fund? Research or tap into your network to see how you can make some more money per month. You can use that extra cash as a reliable income to build your fund. What can you sell to jump-start your fund? Are you receiving a big payout somewhere? Can you ask for a raise at your job? Do you have a business idea that you've been toying with? How can you get scrappy so you can increase your income and save more money? Take a moment to get a bit creative and excited about the possibilities.
5. Track your progress.
Schedule regular money dates with yourself to track your progress in saving for your emergency fund. Have you been meeting your weekly and monthly goals? After two months, if the total is less than what you've decided to save monthly, spend less next month and increase your contributions to the emergency fund until it reaches the goal; then stay at that amount until it's time to raise the goal again.
Tracking your progress also helps you to review your expenses. Are there any other expenses that you can forgo? Where can you do more of and where can you do less? It's okay if you don't reach your monthly goals; there can be a lot of shame surrounding finances. The goal is to keep going even if you fall off track momentarily. Tracking your progress also helps to keep your money goals top of mind. It's easy to get sidetracked by life. Therefore, these monthly money dates will hold you accountable.
6. Don't use your emergency fund for non-emergencies.
The biggest mistake that most people make is, dip into their emergency funds with the idea that they'll replenish it next time. Dipping into your funds takes away the discipline and hard work that you've achieved over weeks and even months. What happens when you continue to fill a bucket with a hole in it? No matter how full it gets, it leaks.
Dipping into your funds derails the habits you've created. Now instead, you've replaced those habits with habits that don't serve your overall goals. Committing to this process creates a financial version of yourself that you'll grow to appreciate. The best way to see your emergency fund grow is to commit to the process—it works without interruptions. No matter what happens, don't dip and ask yourself what you did before the emergency fund? You lived without one for a long time. Pretend to live without one until it's fully funded.
7. Once you fund your 3-months emergency fund, it's time for another one.
Once you've got an emergency fund, it's time to start saving for another one that will cover the goal of six or 12 months (or more) worth of expenses if something unexpected comes up. This will feel much more doable once you've completed the first 3-month milestone. Think of your emergency fund as a ladder that leads to financial stability and new financial habits. Each fund builds on top of the other. You build an emergency fund gradually over time.
Life is full of surprises. Little things can come up and can throw a kink in your monthly budget (and income). Having an emergency fund is vital to gaining peace of mind. Start with the basics: make sure you're earning enough to pay your bills and save a little money on top of that. Once you have these basics in place, build on them using one or more of these easy-to-implement methods. Implement this 7 step-by-step formula, and a financial crisis won't be a crisis anymore because you're financially ready to solve it.
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