How to Start an Emergency Fund on any Budget

Yes, you really do need an emergency fund. Sure, there are exceptional people out there who never get sick, never have a car repair, and never lose their jobs. But I’m not one of those people.

Over the last few years I’ve had knee surgery, totaled my auto in a freak car accident, and have pounded the pavement (without a car and with a new knee) in search of work.

I doubt my streak of bad luck is unusual, and I bet you’ve had some tough times during this recession too. So unless you’ve got a horseshoe permanently lodged up your a$$ (and you don’t, ’cause no one designs pants to accommodate equine footwear) then you’d better build yourself a financial safety net and start an emergency fund. Here’s how to do it on any budget.

Step One: Stop Whining

Now don’t go and pull a fast one by telling me you don’t have an emergency fund because you’re broke. I don’t like whiners, and I know The real reason you’re broke, so it’s time to cut the crap and accept that saving something for a bad day is a surefire way to stay afloat. And since I want you to have a personal flotation device (that’s a life jacket), it’s time to silence that pesky voice telling you that saving something is impossible. It’s possible. Believe it.

Step Two: Know what you need.

I have a sizable emergency fund. I have zero debt, no kids, a frugal husband, and a dog. So why do I keep six months worth of expenses in a safe place? It’s simple. I’m a freelance writer with highly variable income — some months I write a bunch and earn the bucks while other months I write a little less. Knowing my income on a month-to-month basis is impossible and I sleep better at night knowing I’ve got the moolah socked away in my emergency fund to make it through the less busy months. I’m also very clumsy (knee surgery, car accident, random acts of falling on my face) and highly retentive — so it’s my style to save big.

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Your situation may be similar, or very different — and that’s OK. The amount of money you keep in your safety stash must be an amount that makes sense for you. Do you have debt? Kids? A mortgage? An illness? Are you single or married or supporting an Ex? Do you live in a single or dual-income household? Are you worried about losing your job? Do you have variable income? And are you clumsy?

Knowing the answers to these questions is a start, but the point here is to get a grasp of your expenses and know how much money you need on a monthly and yearly basis. Download the free budget spreadsheet to figure out your finances and better understand your household costs. Once you know your financial needs, it’s far easier to set your financial goals and aim for a modest emergency fund.

How much is enough? What the gurus say!

In The Total Money Makeover, David Ramsey advocates taking baby steps towards financial fitness. His first baby step is to start a $1,000 Emergency Fund.

“This beginning emergency fund will keep life’s little Murphies from turning into new debt while you work off the old debt. If a real emergency happens, you can handle it with your emergency fund. No more borrowing. It’s time to break the cycle of debt.”

Ramsey’s later steps include building 3 to 6 months of expenses in savings. “Use this money for emergencies only: incidents that would have a major impact on you and your family,” he says.

In The Wealthy Barber, David Chilton writes, “I’m not against emergency funds, but I do feel that $2,000 to $3,000 is much more realistic than $10,000. If you’re afraid that an expensive emergency looms in you future, establish a $10,000 credit line at your bank.”

Gail Vaz-Oxlade, author of Debt-Free Forever and host of Til Debt Do Us Part, says saving up six months’ worth of essential expenses in an emergency fund is a key component of any sound financial plan (source). And she is no fan of people taking “The Easy Way Out” by tapping a line of credit for emergencies.

“Bah! How is going into debt on a line of credit during an emergency a sensible solution? It’s not. It’s the excuse people use for not saving! Plain and simple, it’s the lazy man’s solution. And it’s expensive, soul stealing and bad planning (or would that be ‘no planning?’).”

There is no ‘one size fits all’ solution to building an emergency fund. Personally, I’m a huge fan of sleeping at night and keeping a sizable safety stash on hand for a bad day. Being prepared for the bad stuff makes me feel pretty darn good.

Step Three: Open a dedicated savings account.

I know you want to be a sneaky sneaker by keeping your emergency fund in your checking account. That’s not going to work, people. It’s just too easy to spend that cash when it’s not isolated, cloistered, and hidden away from sulfurous spend-thrift ways. To do this right, you really must open a dedicated account earmarked for emergency savings.

But where do you park these savings? Most checking accounts pay peanuts on on balances and interest rates are still near record lows. One of your best safety net bets is to find a high-interest savings account that’s easy enough to access, but out of reach enough to leave be. To find one with a fair interest rate, check out CANNEX, an independent company that compares interest rates and other financial data, and pick Canada or the United States to locate an account close to home.

If you find a financial institution offering a better interest rate than your current account, use the Switch Bank Accounts Checklist to help move your money to a more competitive place.

Step Four: Find strategies to save.

I’m not leaving you alone, sitting at the computer, with an empty account boasting a decent interest rate. Ah shucks, that would suck. I can just see the emails flying in now: Gee, Thanks Kerry!, Now what?, Is that all there is? To keep my inbox a happy place, here are five common sense strategies to help fund your new emergency savings. No, they don’t suck, and yes, they do work.

  1. Start simple, start small. Rome wasn’t built in one day, and your emergency fund won’t be either. So take a breather and start small by squirreling away $10, $25, or $50 each paycheck. It doesn’t sound like a lot, but this cash will add up.
  2. Schedule your savings. One financial guru calls it an automatic deduction, I just call it scheduling in some common sense. Many bank accounts let you transfer money at regular intervals on a schedule. If you automate the process you won’t hesitate to pull the savings trigger. Pick a day each month, automate the money move, and watch your emergency savings grow.
  3. It’s a bill, so pay it. You pay your bills, right? Treating your fledgling emergency fund as a bill could help you to boost savings faster. You wouldn’t want to skip paying rent, phone, or internet, so don’t skimp on paying your savings fund. Changing your mindset from should do to must do is how to make it work.
  4. Hit your pay before it hits your hands. Some people just can’t resist the call of cashing in a crisp new paycheck. If you’re one of these people (be honest), contact your human resources department and ask about setting up a payroll deduction directly into your savings account. If you can’t touch the money, it won’t run away from you.
  5. Slash, cut, and save. This is where I get mean and tell you there’s money leaking out of your life — you just need to know where to find it. Downgrade your TV package, cancel that gym membership, and try any of these 50 Ways to Save $1,000 a Year to make that emergency fund a reality. You have the money, you just have to want to save it.

Got another strategy that works? Go ahead and share your thoughts in the blog comments. There are a lot of ways to trick your mind into saving — let’s hear yours!

Step Five: Ne pas toucher.

That’s French for: Do not touch. If you’re an English speaker, then you’re not allowed to tap your emergency fund either — unless it’s a REAL emergency. And a shoe sale is not a Squawkfox-sanctioned four-alarm emergency (even though I do love shoes).

An emergency is an unforeseen circumstance that leaves you up the creek without a paddle. Since you have that life preserver (your emergency fund) you won’t tap your credit cards and drown in debt, you won’t miss a mortgage payment, and you’ll have some wiggle room to rejig your budget until the emergency passes. And when you’re back on your feet, it’s time to start saving again to replenish your emergency fund.

Are emergency savings idle funds? I don’t view my six months worth of savings sitting in a high-interest savings account as a waste or as a poor investment. Since I’ve needed that cash on several occasions over the last few years, I think funding my safety is the best investment I can make. Sleeping well at night is nice too.

Your Turn: How much do you keep in your emergency fund? Do you have one? Ever use it?

Your two cents:

  1. Neil November 2nd, 2010

    Ah, the emergency fund, the idiot stepchild of personal finance advice.

    The problem with the “Emergency Fund” is that it’s misnamed, and thus misinterpreted. It’s really not important at all to have enough cash lying around to deal with an emergency…it’s important to have enough liquidity (cash or debt instruments like a line of credit) to deal with an emergency.

    The problem with having a savings account to deal with emergencies is that that money is coming from somewhere. If you are someone in debt, you could have alternatively used that monthly savings to pay down your balances. To respond to Vaz-Oxlade’s comment: Does it make sense to pay $185 per year to maintain a $1000 emergency fund (1.5% savings rate to 20% credit card rate) when you could save the interest and borrow the principle again when you need it?

    As it applies to someone with savings: does it makes sense to give up your potential investment gains in order to keep $10k sitting in a savings account, when you could just borrow that money for a few months, only when needed, for a similar price?

    The cost in both cases is actually higher because of the compounding nature of interest and investments.

    If we’re honest about what the “Emergency Fund” is really about, we find out that it’s actually the “Psychological Boost Fund.” For people in debt, seeing that they can save money and not be broke all the time is a great relief. And for some people on either side of “zero net worth,” it can be an encouragement to actually improve their savings rate. But since it’s a psychological boost rather than a real, mathematically sound, financial boost, could we please stop pretending that it’s right for everybody?

    Everybody needs a budget. Not everybody needs a pool of cash sitting around, doing nothing.

  2. Laura November 2nd, 2010

    I use my debit card for as many transactions as I can because I can track my expenses better this way using Mint.com (and my debit card rewards me for using as a credit card). If you have your checking and savings accounts at the same bank, it’ll be easier to set up automatic transfers. Some banks even have programs where they’ll round debit card transactions up to the next dollar and put the change into your savings account. Since I don’t use cash often, this has helped me save up in a manner similar to a piggy bank.

  3. Emr November 2nd, 2010

    I have a TFSA for my emergency fund. It doesn’t earn a whole lot of interest, but at least I’m not paying tax on the cash :)

  4. Steve November 3rd, 2010

    I struggle with how much should I target for our family emergency fund (wife, 2 kids, a dog and a mortgage, car loan and credit cards). We currently contribute $100 every two weeks and have been doing this for approximately 5 years. Any thoughts?

  5. Bee November 3rd, 2010

    Great post!

    Under Your Step 4: Strategies to Save’s 5 point List I’d add — #6. Sell Your Crap.
    When times are tight and you know you need to build that emergency fund where is that extra $20 going to come from? Sell your crap! Craigslist, Ebay, Garage/tag sales, Amazon= do what it takes.
    So many of us have crap, even used crap that others want and are willing to pay for. Sell your crap to build your Emergency fund. Better to sell the old second couch today and have access to funds when you need them instead of having a crisis on your hands and THEN taking the time to try to sell the clothes/ old couch/dead mower/baby stuff/etc when you needed the $$ yesterday. As Tim Gunn would advise, “Make it work.”
    And NOW is a great time to be posting stuff on craigslist. If you live in the states Nov. 1- Nov. 10 Ebay allows free postings (Maybe true in Canada too?). Frugality is sexy. Getting $ for crap is sexy. Simplicity gained from selling clutter and excess is sexy. Peace of mind of an Emergency Fund is sexy.
    #6. Sell your Crap works for me!

  6. John E November 3rd, 2010

    Another good thing about an emergency fund is that if it grows big enough, like big enough to cover six months (or more) of living expenses in the big city, it turns into attitude money. Then, when you start to hate your job, you can calculate just how many years your emergency fund would last if you were to live cheaply in a grass hut on a small island in the South Pacific. You may never quit your job and move to the South Pacific, but every time your boss annoys you, you can dream about it…

  7. Katie Mae November 3rd, 2010

    My husband and I keep about $11,000 (6 months of expenses, more if we cut back) in an online savings account. We call it our “uncertain future fund.” We haven’t dipped into it yet, but we will if there’s a medical or car emergency, if I lose my job, if we get pregnant (eek!), or if we decide to move and have to cover two rents or rent and a mortgage for a while. Like John E said, it gives us a chance to try out a financially risky idea (like kids, going freelance, or moving overseas) if we want to.

  8. erzebet November 3rd, 2010

    i do have an emergency fund and it was one of the best decisions of my life – i have more control over my destiny and i can approach opportunities, not only emergencies.

  9. Steve November 3rd, 2010

    I agree that if anyone is motivated they can establish a small emergency fund by working a little extra and reducing their expenses slightly.

  10. queen of string November 3rd, 2010

    I have one, it’s called the f*** you fund. I used to use it in the same way that another poster suggested, it meant I was never stuck in a job. I could at any time tell the boss where to go. Now we are having a mini retirement, it’s the point at which we stop trying to be creative and one of us gets a proper job!

  11. Melissa Tosetti November 4th, 2010

    I am a big advocate of baby steps. It’s much easier to wrap your brain around an initial goal of savings $100 and then working your way up from there, than starting with a goal of saving $10,000 and getting overwhelmed. Also, with each small goal achieved, your financial confidence increases.

  12. Nick November 5th, 2010

    @Neil I must agree with you. The “emergency fund” is one of those overused phrases that really are just used to keep one sleeping at night…along with “asset allocation” and “portfolio diversification”

  13. Ana November 10th, 2010

    “Pay yourself first” is the best financial advice I was ever given. I’m a fan of the emergency fund. For the ones who bash it that the money should be “invested,” all I can say is that my 401K investments have tanked, and meanwhile, my emergency fund (around 6 months) is happily sitting in the bank, minding its own business, making me much more relaxed than I was before it existed. Yes, it’s possible!

    My strategy was this: I get paid every two weeks. Most expenses are monthly, a couple utilities are bi-monthly and quarterly … how do you budget when none of the dates line up? Used to drive me nuts. Two years ago, I created a big spreadsheet that I now use to budget each bi-weekly paycheck into the bills that need to be paid. The first bill is, of course, my savings account. Also, I have no credit card debt, but used to. The way I paid it off (or pay it off now if I do charge something) is to make an online credit card payment every paycheck — bi-weekly in my case. The balance goes down much quicker this way.

  14. Michael V November 10th, 2010

    I started working on my finances again seriously a few years ago. Tried to get as much info as possible. Clark Howard, Kiplinger’s, Dave Ramsey, ect… By following their path I have no credit card debt, no consumer debt, Bought an REO at the bottom @ 4.6% and built an emergency fund. I imersed myself in following other success stories. We’ll three months ago my emergency came. I got a life threatening heart valve disease and had a major stroke. I am now out of work and on disability. Had I not prepared for the worst and had my financial world in order, I would be ruined. I have a living trust set up for my wife and things are ok. These financial tips due work so get your finances in order. Follow the advise. It works.

  15. Jen November 10th, 2010

    Neil and Nick…your both stupid! Murphy love idiots like you enjoy your debt and stress!

    Queen of String….I love it and I love your spunk!

  16. Carol November 10th, 2010

    Budgeting for emergency fund or any other expenses takes planning and “STICT TO IT” will power. My first job was paid bi-weekly in check. There was no direct deposit at that time. I cashed the check and divided it in half down to the penny and placed both in separate “pay envelopes”. I then lived on my first envelope and did not, under ANY circumstances touch the second envelope. On the following Friday, I was again paid with the second envelope. I learned very early that living on a budget was the only wise way to create a financial basis that carried me through my 55 yrs of working. When my husband and I both worked and we had 2 children, I budgeted using only my husbands pay for our living expenses. My pay was my emergency fund. We never missed a mortgage payment, our bills were always paid on time and if credit scores existed then, we would have had 850 or better!!! We lived within our means and if we wanted something, we saved for it and paid cash or bought second hand. I do have an emergency fund today of $102000.00 but because of a lifetime of being financially responsible, I have no debt and my retirement is secure. And we did not have exceptionally high paying jobs, my husband was a supervisor and I was a secretary, but we learned early on that if we could not afford something that our friends had or wanted to do, we spoke up and said we could not afford it. Most of the time, they were pleased because they couldn’t really afford it either but they were more inclined to be “big spenders”. If everyone learned to live within their means INCLUDING OUR COUNTRY, we would all be much better off.

  17. Diana Mathew November 15th, 2010

    Hi! This is such a great article and I am sure a lot of money saving enthusiasts are going to benefit from this. Keep it up! I am Diana Mathew, an Australian Entrepreneur, ebook author (The Money Tree by Diana Mathew) and a Saving Money guru.

  18. cmdweb November 16th, 2010

    We tend not to budget for generic emergencies, but more for the known expenses we have to take care of. Things like car insurance, car servicing, car tax, TV licence (we’re in Scotland), etc. By budgeting enough, we can generally cover off any emergency. We’re lucky here though that we don’t need to cover health costs – although we might expire waiting for an appointment…

  19. lcmama November 23rd, 2010

    I think that an emergency fund would be great to have. But if you are in the bottom rung of society that is more of a luxury than a reality, like taking a vacation. You can try to save money but when basics like rent, food, gas, electricity and such keep rising more and more every year, while you have not received even a small raise in 3+ years at your work, it is near impossible to save up. Yes we could save maybe 20 dollars a paycheck and with that it will take us about 20 YEARS, to save just 6 MONTHS worth of funds. Now that is hoping that nothing serious happens in those 20 years, we do not get fired, and there is absolutely 0% inflation on non-volatile goods, (food, energy).
    Before you say to get a second job (very hard when everyone and their brother are also looking) or to just work extra hours at the job you have to make some overtime, try to remember not every company will let you. Some would rather you not work overtime hours because then they will have to pay you time and a half.
    To summarize if you are in the middle and upper class it makes sense to have an “emergency fund” so you can sleep at night. If you are in the lower class, it makes more sense to pay your basic bills and be able to sleep with a full belly and a roof over your head, and maybe be able to keep the lights on too.

  20. nick November 29th, 2010

    @jen not sure why you would consider me stupid… my statement was pretty straightforward. All the people who stuck to asset allocation and diversification are looking at their portfolios and realizing that they won’t be able to retire when they wanted to and it will take them over twice as long to make up for the losses. A shift in thinking is not stupid, doing the same thing and expecting different results is stupid.

  21. Claire June 1st, 2011

    I have to agree with Icmama. I live by myself – work as an administrative assistant, pay my bills on time, don’t eat much, but with the gas prices and the ripple effect that has caused for groceries, electric bill, etc. – it can be very difficult to save. I have worked two jobs and may have to do that again, but if the 40 year olds are finding it difficult to get one job, what do you think about the 50 year old trying to get a second job. However, I work very had to keep a budget, but I have had some unforseend expenses hit my savings hard.

  22. Bella February 25th, 2012

    This is all well and good…for those who have a job… I’m currently unemployed, as is my husband… I can totally relate to what Claire said in her reply on June 1st 2010, about it being extremely difficult to find a job when you’re in the 40+ bracket. Its a sad, sad day when there are more people needing jobs then there are jobs available. We have 2 kids ( well adult children ) one of which just got married and will be moving sometime in May, our furry daughter (our dog), and a friend that is also unemployed (in the same 40+ bracket)living with us. This makes it very difficult to make ends meet for our regular monthly bills: car insurance, electric and utilities, phone, internet (needed to even apply for jobs these days… What the heck happened to the paper applications anyway?), buy food to eat, rent/mortgage, … well as you can see its not easy to save money…

    Enough said..

  23. Rachel November 6th, 2012

    What works best for me is a savings acct that is not connected in any way with my regular chequing/savings acct. I put money into it regularly and also I have found having a deposit box of my own in their vault is a nice feeling. I always feel I should not touch it and once made it to not taking the money out for over five years. It was great.

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