Could you afford to cover a $1,000 expense out of pocket? If you haven’t started an emergency fund yet, the answer is almost certainly no.
You’re not alone. According to a 2022 PYMNTS survey of about 3,500 U.S. consumers, 60% of Americans live paycheck to paycheck. They’re unable to cover even the smallest emergency expenses without taking on new debt, which is often the first step toward chronic financial insecurity.
Millions more Americans have some savings, but not enough to cover major or ongoing expenses or income losses: hospital bills, vehicle or home repairs not covered by insurance, extended bouts of unemployment or underemployment. Hardships like these demand robust emergency savings that can replace several months of expenses before they’re gone. Starting such a fund can feel like a daunting task — but it’s manageable if you know where to begin.
Follow these steps to get your emergency fund off the ground and set yourself up for success as you work to build it.
If you already have a working budget, you can skip this step. If not, your goal here is not to craft a down-to-the-penny cash flow model but to arrive at a solid accounting of your current financial situation. That is, you want to know how much money you bring in each month (which should be straightforward if you have a W-2 job and no other significant income sources) and how much you send out the door in the form of expenses.
On the expense side, you especially want to account for nondiscretionary expenses like:
For categories where your spending varies from month to month, like groceries and utilities, add up your spending over the past year and divide by 12 to arrive at an average monthly spend.
Next, account for discretionary expenses, which are “nice-to-have” but nonessential purchases like meals out at restaurants and leisure travel. Since your discretionary spending probably fluctuates from month to month, you’ll want to figure out your monthly average here as well. While you’re doing this, look for low-hanging opportunities to trim your discretionary spending and free up additional cash to throw at your emergency fund.
Next, open the high-yield savings account that will hold the bulk of your emergency savings (or at least the first tranche). FDIC-insured online banks tend to offer the best yields, rather than big brick-and-mortar banks like Bank of America and Citibank.
Do spend some time making sure you’re getting a competitive yield, but otherwise, don’t stress too much about this step. It’s more important to get a separate account open soon so you can start saving without being tempted to tap excess funds in your checking account.
Once you open your savings account, look for opportunities to boost your emergency savings early on. Generous bank account opening promotions aren’t super-common in the savings account world, but they’re out there and usually worth it if you can qualify.
If not, look for checking accounts with new account bonuses, which are often easy to attain with a modest recurring direct deposit. You’ll need to keep the bonus in your account for a few months, probably, but after that you can transfer the balance to your emergency savings account as a down payment on financial security.
Take advantage of other one-off windfalls early on as well. The best opportunity will probably be that year’s tax refund. Depending on how much you overpaid, that could add a few hundred or maybe a few thousand dollars to your nest egg.
Next, decide how big your “full” emergency fund needs to be.
Measure this amount in both dollars and months of expenses at your new burn rate. For example, if you spend $3,000 per month and you want your emergency fund to cover 6 months’ expenses, you’ll need to save $18,000. If you spend $4,000 per month and you want your fund to cover 12 months’ expenses, you’ll need to save $48,000.
The general recommendation for people with steady jobs is a minimum of 3 months’ expenses, and 6 months to be safe. If your finances are more precarious because you’re self-employed or have irregular income (even if traditionally employed), you’ll want a larger cushion, on the order of 9 to 12 months.
Starting from zero, saving this much probably feels like an impossible task. So set a more realistic goal to start: $1,000 in your emergency fund. Even at a modest pace, you can reach this goal in a matter of months, or maybe weeks if you can make significant budget cuts upfront and maintain discipline.
Once you hit your initial goal of $1,000 in your emergency fund, pause and pay off some or all of your unsecured debts. Reducing or eliminating those payments will free up more money for savings, and you can then turn your attention back to your emergency fund.
If you don’t want to wait until you’ve paid off all your unsecured debts, focus on the ones with the highest interest rates and longest terms first. These are almost always credit card debts. Use the debt avalanche or debt snowball method for more efficient paydown.
You might not feel like you’re in the home stretch yet, but from here on out, it’s a matter of patience and simple math. Chart the rest of your course toward full emergency savings by setting a realistic monthly or biweekly savings goal that accounts for your current cash flow and any remaining debt service.
Divide this number by your emergency savings target to figure out how long it’ll take to reach your goal. Adjust as necessary and as your budget allows — increasing your monthly or biweekly savings amount to reduce the time to full funding, or decreasing it to boost your spending power in the here and now.
Don’t leave your emergency fund deposits to chance. Schedule regular transfers from your checking account to your emergency fund, ideally every pay period but certainly at least once per month. Or split your paycheck between your checking account and your savings account so that you’re not even remotely tempted to shortchange your future self. Most HR systems allow this.
Your emergency savings fund doesn’t need to reside entirely in one savings account. In fact, you could come out ahead in the long run by dividing it into different accounts, some of which earn more than plain-vanilla savings.
For example, a 12-month CD could pay 1% or 2% more interest than a savings account, the only catch being you can’t access your funds without penalty until the end of the term. If you don’t anticipate needing your entire fund in one go, allocating a portion of it to higher-yield, lower-liquidity accounts will ultimately help grow it faster.
Finally, plan to celebrate legitimate milestones on the road to fully funding your emergency fund. You can define these milestones however you see fit, say:
Before you begin saving in earnest, plan how — and when, based on your expected savings pace — you’ll reward yourself for reaching each milestone. Brainstorm reasonably priced splurges like dinner and a movie or a new personal accessory. Circle a proverbial date on the calendar for each. And look forward to maintaining your motivation without breaking the bank.
With the exception of pausing at $1,000 saved to pay down high-interest debt — a potentially open-ended project that you’ll want to set limits around for your emergency fund’s sake — you can knock out each of the items on this list in a day or less. Some in far less time. Opening a bank account online takes maybe 10 or 15 minutes if you don’t get distracted. Automating your savings takes 5 minutes, if that.
Which is to say that starting your emergency fund is the easy part. Maintaining discipline is more challenging, which is why it’s so important to set a realistic pace and reward yourself along the way. But financial peace of mind is worth every hour — and every penny.
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