How To Set Up Your Emergency Fund

Your emergency fund can help you cover the cost of life’s unpleasant surprises like illness, house or car repairs, or even job loss. Without one, these unfortunate situations become even worse, as you could face tough decisions when things don’t go according to plan.

Taking on credit card debt is a major setback that can hinder your ability to reach your goals. Similarly, dipping into your retirement funds can mean selling assets from your nest egg when the market is down or, alternatively, spending cash that could otherwise buy assets in your portfolio on the cheap.

Building an emergency fund should be one of the first goals everyone pursues, but many fail to do so. One reason for this is our human tendency to believe bad things are more likely to happen to other people than ourselves. Another reason is that building an emergency fund takes time and just isn’t as exciting as other life goals.

However, consider how an emergency fund supports your other life goals. It provides flexibility to take other risks in your life such as starting a business or taking a year off from work. Those sound like positive and exciting life experiences, right?

Here are some basic pointers for setting up your emergency fund.

How Much Cash to Keep in Your Emergency Fund

An emergency fund should contain 3 to 6 months of living expenses. Within that range, the specific size of your emergency fund should correspond with your level of job security and the potential volatility of your income.

Doctors and tenured professors have more predictable incomes and could get away with keeping smaller cash cushions for emergencies. Someone working in an industry that’s more sensitive to changes in the economy such as construction or finance, on the other hand, may want to maintain a bigger emergency fund. Dual-income families can get away with a smaller cash cushion as well, while single-income families may want to hold a bigger amount.

3 to 6 months of living expenses is a lot to set aside, but don’t let that overwhelm you or prevent you from getting started. An emergency fund is rarely built overnight (and it doesn’t have to be!).

Building Up the Cash for a Rainy Day

If you start from scratch, the best way to build an emergency fund is to contribute a very manageable sum to a designated savings account every pay period – and make it an automated piece of your financial plan.

Set up automatic contributions from your primary checking account to your emergency fund after each payday. Start small and make sure that you can still live comfortably with your remaining income.

You can start with a one-month starter fund to get started. After reaching that goal, make a modest increase to the amount you contribute to your emergency fund and go for a 3 month emergency fund. 

After 3 months, you could increase your contribution again and consider taking steps to build up to a 6 month emergency fund. 

The Best Place to Stash Your Savings

The best place to keep an emergency fund is in a savings account, separate from your primary bank. 

Online banks often pay higher interest rates than the traditional brick-and-mortar banks. While higher interest is good, it’s usually not worthwhile to constantly change banks to earn a few extra fractions of a percent.

If you’re just starting out, pick a familiar bank or one that you are most comfortable using.

A savings account doesn’t just boost your interest earned on your emergency fund. It can make it easier to make good behavioral choices, too. 

By keeping your emergency fund in a bank that is completely separate from your primary checking bank, it’s much easier to resist the urge to dip into those funds for non-emergency purposes. That will help ensure the money is there when you need it – no matter what kind of curveballs life may throw your way.