5 Essential Steps to Start an Emergency Fund

In today's ever-changing financial landscape, it's more crucial than ever to have a safety net in place for unexpected expenses. However, nearly half of us lack adequate emergency savings, according to recent data. A 2023 Bankrate survey revealed that a startling percentage of Americans - only 48% - say they have enough emergency savings to cover at least three months’ worth of expenses. Meanwhile, a substantial 29% have less than $500 in their emergency savings, according to a new Edward Jones survey. 

Building an emergency fund is not just a basic financial strategy, but an essential pillar of long-term financial stability. In this article, we'll delve into five essential steps to start your own emergency fund, underlining why these steps are not just prudent but imperative.

1. Make a Budget

Making a budget might sound like an elementary step, but it's the bedrock for your financial future. It provides a clear roadmap for your finances, ensuring that you allocate a portion of your income toward savings - including your emergency fund. 

And without a budget, it's easy to let discretionary spending and unplanned expenses wipe out your ability to save for emergencies. A budget empowers you to regain control over your finances and allocate resources efficiently, making it an ideal first step to creating an emergency fund.

To start creating a budget, begin by listing your sources of income - including your salary, freelance work, rental income, and any other revenue streams. This step helps you understand the total funds available for allocation. From there, categorize your expenses into fixed and variable categories. Fixed expenses include necessities like rent or mortgage payments, utilities, and insurance premiums. Variable expenses might encompass groceries, dining out, entertainment, and any non-essential purchases. Don't forget to leave some cushion for those occasional irregular - but predictable - expenses, such as annual subscriptions or car maintenance.

Be sure to include recurring funds in your budget for debt repayments and savings, which we'll get into more later. And, of course, allocate funds towards your emergency savings. 

If you're looking for help to build a basic budget, there are several apps to get started. These include Mint, YNAB (You Need a Budget), and Personal Capital. 

2. Set a Goal

Creating your personal budget is a great first step, but setting a clear savings target is also paramount. A well-defined goal helps by guiding your saving efforts and instilling discipline in your financial behavior.

Experts recommend having three to six months of living expenses in an emergency savings fund. This benchmark provides you with a tangible target to work towards, but your own personal goal should align with your lifestyle, risk tolerance, and financial aspirations. Are you the sole breadwinner in your family? Do you have dependents? Consider these factors, as they may affect how much you want to stash away for potential emergency expenses. 

This is where that monthly budget comes into play. Your monthly budget is more than just a financial roadmap, it's a valuable tool for extrapolating your emergency fund goal. Start by reviewing your monthly expenses, and going over your lifestyle and personal circumstances. 

From there, multiply your total monthly expenses by your desired savings duration. For example, if your monthly expenses amount to $3,000, building an emergency savings fund to cover three months of expenses would give you an initial goal of $9,000. Of course, you'll want to be sure to adjust this target to account for any new or increased expenses as they hit your budget.

3. Set Up Direct Deposits

Direct deposits ensure that a portion of your income is automatically funneled into your savings account before you have a chance to spend it. 

This method aligns with the concept of "pay yourself first" and ensures that your emergency fund steadily grows without any additional effort. It's one easy, proactive step towards securing your financial future, and keeps payments simple and consistent.

There are a few ways to set up direct deposits. First, you can reach out to your human resources department through your employer to set up direct deposits. They will provide you with the necessary forms or instructions. Typically, you'll need to fill out a direct deposit authorization form, which will usually provide the option to specify either a fixed dollar amount or a percentage of each paycheck that you want allocated directly to your emergency fund account. Be sure to determine an amount that fits comfortably within your monthly budget, and also helps you progress towards your savings goals. 

If your checking and savings accounts are at the same bank, it's also possible to set up internal electronic account transfers directly through your lender. This is generally a simple process that can be accomplished through your bank's online portal or mobile app. Simply indicate the amount or percentage you want transferred from your checking to your savings, along with a recurring frequency if you'd like. (This can also be done externally from one bank to another, though that process generally requires account confirmations and can take a few extra steps to set up.)

Once direct deposits or transfers are established, you can rest assured that a portion of your income will consistently flow into your emergency fund, bolstering your financial security over time.

4. Use Extra Income Wisely

When your salary increases or you receive extra income, such as a bonus, consider allocating a portion of that windfall to your emergency fund. This practice not only accelerates your progress but also prevents lifestyle inflation from eroding your financial safety net. It's about turning your income growth into financial security, ensuring that you're well-prepared for unexpected financial challenges.

So, should you receive a salary increase, consider making a percentage or dollar amount adjustment to your target emergency savings amount that better aligns with your new salary. If you're already leveraging direct deposits for hands-off savings, this is an easy change to make.

Plus, consider using your bonuses to prioritize your savings. It's tempting to splurge this kind of windfall on discretionary spending, but even allocating a percentage as low as 30% can significantly boost your savings.

If you're receiving a tax refund, this amount can also be leveraged for savings rather than immediate spending. Since these one-time cash infusions aren't built into your regular budget, diverting them directly into your emergency savings whenever possible can significantly bolster your financial safety net.

5. Avoid Getting into Debt

A recent CNBC survey highlights that more than half of Americans describe themselves as living paycheck-to-paycheck, including a third of people with six-figure household incomes. This precarious financial situation makes it essential to keep a tight rein on debt, especially high-interest debt.

Debt, whether in the form of credit card balances, loans, or other liabilities, can divert a significant portion of your income toward interest payments and debt servicing. This leaves less disposable income for savings and building your emergency fund. 

Furthermore, in times of unexpected expenses or emergencies, servicing existing debts can become even more challenging, potentially leading to a cycle of further debt accumulation. That's why staying on top of existing debt payments, and avoiding the accumulation of new debts wherever possible, should be built directly into your budget. 

While building your emergency fund is crucial, prioritize debt repayment if you have high-interest debts, and make sure to follow the debt payoff plans outlined in your budget. Paying off high-interest debts first will ultimately free up more funds for your emergency fund over the long term.

Bottom Line

The importance of having an emergency fund cannot be overstated. To start your emergency fund journey, begin by creating a budget to understand your financial landscape. Set a clear savings goal that aligns with your lifestyle and risk tolerance. Automate your savings by setting up direct deposits to ensure consistent contributions. Use extra income to boost your fund, and most importantly, keep a tight rein on high-interest debt that could jeopardize your financial security.

In the end, it's not just about creating an emergency fund, but creating financial resilience and peace of mind. By taking these five essential steps, you're not only building a financial cushion, but also securing your financial well-being for years to come.