Takeaways
- Save at least $1,000 to $3,000 to blunt unexpected expenses.
- Keep your emergency fund in a high-yield savings account.
- Adopt a budgeting strategy that lets you accrue emergency savings quickly.
- Saving goals should be part of your long-term financial goals.
- Topping off your emergency fund should be part of regular financial hygiene.
Virtually every personal finance advisor has one rule; make sure you have an emergency fund. This is especially true if you are just starting to get your finances together for the first time. An “emergency cushion,” as it is aptly named, is meant to stop you from dipping into your savings account in the event of unforeseen emergencies such as being laid off, unexpected medical bills, or a random accident.
The majority of Americans have less than $1,000 in their savings account [1]. As one might expect, this can cause significant problems when unexpected bills arrive. For those who don’t have savings for emergencies set aside, the temptation to pay for these bills with credit cards is hard to resist. For the unprepared paying for credit can spur or perpetuate a credit card debt cycle. It is better to be on guard for the inevitable emergencies because they will happen.
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Most personal finance experts recommend having at least $1,000 saved to cover an emergency. Others advocate for up to $3,000 for emergency funds. No matter the number, planning for unexpected expenses is part of maintaining your financial health. This step-by-step guide will help you reach your emergency savings goal one step at a time.
7 Steps to Create an Emergency Fund
This step-by-step guide will help you reach your emergency savings goal one step at a time.
1. Analyze Your Spending
One of the main reasons for a lack of savings is overspending. Take out your credit card bills and print out your bank statements from last month. Categorize how much you spent on these areas: eating out, clothes, nights out with friends, and travel.
As the British economist Tim Jackson says, “We spend money we don’t have, on things we don’t need, to make impressions that don’t matter.”
Analyze how much you spend each month on things “that don’t matter.” It might give you a new lens to view your past spending habits.
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2. Create A Budget
Once you have taken a hard look at your spending, the next step is to create a budget. Add up all your revenue streams throughout the month and subtract all your monthly expenses. The difference is your operating margin. It is awesome news if you have a positive number. But if you are running a deficit, you should either increase your revenue or decrease your expenses. The latter is faster and easier for most people.
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The budget creation process is a terrific way to analyze your finances on a cursory level and gain a high-level snapshot of what is happening in your financial life. Now it is time to plan out for next month and find areas for improvement.
Here are some common categories to quickly save cash:
- Dining
- Travel
- Fashion
- Transportation
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There are always weak areas in the budget; you just need to find them.
3. Set a Savings Goal
Goal setting is one of the best ways to achieve success. Writing down how much you want to save in the first month can be the difference between behavioral change or no change at all. An important point here is to be realistic with your saving goals. For example, if you don’t have an emergency fund, try to begin saving at least $100 monthly.
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While this might not sound like much initially, if you can save $100 monthly for a year, you would exceed the $1,000 recommended emergency fund amount. If $100 becomes too easy after a couple of months, you can ramp up your savings to exceed your savings timeline.
4. Pay Yourself First
When the monthly bills start to roll in, you probably tend to want to pay everyone else first – the credit card company, the student loan lender, or the landlord – as a result, it seems like you end up with a meager portion of your income left over to enjoy. Breaking this payment cycle is the key to savings success, and it starts with – putting yourself first. Ensuring that you have discretionary income to put toward your financial goals can be the difference between success and failure.
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Instead of paying your credit card bill first, put money into your savings account and pay yourself first. You are the one working every day – showing up, succeeding, and earning that paycheck. Reward yourself every time cash hits your bank account and allocate savings to your emergency fund account. Paying yourself first will increase your mental and financial well-being.
5. Automate Your Payments
After the momentum of saving for an emergency fund, it’s time to automate the savings process. Automating your finances can save you time, money, and energy while producing optimal results. Out of sight, out of mind truly pays off in personal finance.
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For example, if you can schedule an automatic transfer from your checking account to your emergency fund on the first day of the month (or the same day that you get paid) it will take the headache out of physically having to perform the transfer yourself. The removal of this affirmative step, or making decisions about your money, streamlines the process of saving. Automate your finances for seamless results.
6. Unexpected Money Goes into Savings
Any unexpected money should go directly into your savings account. It might be nice to visualize what you could purchase with your newfound cash infusion but leave it for the daydreams. Your life might not be altered by a cash windfall, but it can certainly transform your savings account. Defer to the future what you were going to buy today.
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7. Celebrate
Good things happen all the time. It is vital to acknowledge and celebrate your successes. Positive psychology research shows that celebrating small wins more frequently can keep you engaged and help you remember what you are working toward [2]. Creating an emergency fund shows a sign of dedication and forethought. Once you reach your goal, make sure to enjoy that accomplishment.
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Saving for the unexpected is not the sexiest thing to do with your money, but staying financially fit will prove useful later down the road. It will be in the moment of need you see the true value of your emergency fund. A good decision today creates a better future for tomorrow.
Smart Summary
Once you have decided to pay yourself first and save an emergency fund, you will need to stash your savings in a safe account. Select one of the best high-yield savings accounts to earn interest income on your saving. Interest income will help you grow your funds over time. Saving your emergency fund for a rainy day is a smart money move.
(1) The State of Personal Finance in America Q1 2023
(2) Harvard Business Review. The Power of Small Wins. Last Accessed January 22, 2024
