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Personal Finance

How to Build an Emergency Fund

Updated Sep 28, 2021   |   5 mins read

Financial experts agree – growing and maintaining an emergency fund makes good financial sense. But what is an emergency fund and how do you get one?

Emergency funds are a stash of cash in a savings account that you can access in an emergency. That is, an actual emergency. It’s not savings for a car or a holiday. The idea behind it is to keep you from bankruptcy or make up shortfall in the event of an unforeseen expense, such as medical bills, or a major life disruption, like the loss of employment.

Financial guru David Ramsey recommends six months living expenses as the ideal, while Suze Orman recommends up to eight months, because that’s the average time of unemployment after a job loss. Three, six or eight months, we all need to know – how do we make it happen? Here are some tips and tricks to get you started.

1. Don’t be Intimidated

Three months income seems an almost impossible amount for some, let alone six or eight. Experienced savers over at ‘The Simple’, suggest that you start small and set a low goal to start, even $250 -$500. Reaching this will give you motivation and you will see that you can achieve what you want. Best-selling author and financial expert David Ramsey agrees, suggesting establishing a $1,000 baby emergency fund as a priority.

2. Establish a Savings Plan

Set up a regular manageable amount that will be diverted to your savings every month. Financial coach Matt Wegner of Matt Wegner Coaching says that “Too many people direct deposit money in their savings accounts, only to turn around and pull the money back out to pay bills. A solid monthly spending plan can help avoid this situation”.

3. Make Direct Debit Your Friend

Have your regular savings amount debited from your spending accounts automatically at set intervals. Bonus points if you can set it up to come out on payday – if you never see it in your account, you can never spend it.

4. Shop Around for High Interest Savings Accounts

If you’re not a regular saver high interest accounts may never have crossed your mind. However, these can be your greatest ally in the establishment of your emergency accounts. David Ramsey suggests that emergency fund should be liquid, that is, in a savings account rather than stocks/investments or term deposits, as this is safer and easily more easily accessible.

Many online savings accounts offer bonus interest if you don’t withdraw, or special introductory rates to entice you to join, so use these to your advantage. It may only be a few cents here and there at first, but every penny counts, so get that stagnant money working for you.

5. Make Lifestyle Changes and Save, Save, Save founder Andrew, suggests that making small lifestyle changes can give you extra money to divert to an emergency fund. You may consider –

  • Taking public transportation when you can, and consider getting rid of your car completely if public transport infrastructure in your area makes this viable.
  • Increase the deductibles on your insurance – increasing the deductible will decrease the premium and even if you have to pay the deductible once or twice, long term you are still going to benefit from the lower premium overall.
  • Selling whatever you don’t need – one man’s trash is another’s treasure. Yard sales, eBay or classifieds are low-cost ways to do this.
  • No new things – don’t always insist on buying new, try to repair what is broken or buy second hand.
  • Keeping track of your bills and paying attention to your bank statements – look closely at bills and see where your peak usage times are for services and try to decrease it or move the activity to an off-peak time to save money. Reconcile all your bank statements as mistakes are not impossible.
  • Being careful with reward and loyalty programs – these seem beneficial in the short term, but usually entice you to overspend. Spend an extra $20 for 500 bonus points seems like a win, but really you are spending $20 for something you didn’t need and getting points worth less than that in return.
  • Eat in and reduce take-away and restaurant meals – food is a huge household expense. Just taking your lunch to work, not buying that take-away double-shot venti latte or simply cutting back on eating out can save hundreds of dollars every month.

6. Think About Your Existing Debt Repayments

Experts disagree about the virtues of establishing an emergency fund instead of paying down debt, but for some, this is a must. Financial advisor Erik Carter suggests that “If the interest rate is over 7%, you’re likely to save more in interest by paying down the debt than you would earn by investing the money”, however he adds “if the rate is below 5%, you’re probably better off investing any extra savings”.

Suze Orman is even more decisive on the issue, declaring that “only pay the minimum due on your credit card balance, and instead, make it your top priority to build as much of an emergency cash fund as you can.” The debt repayments over and above the minimum can be rerouted to your emergency fund until your first goal is reached.

>> Read More: How much money should you have in an emergency fund?