Nobody wants it, but emergencies happen. Whether it's a sudden car repair, an unexpected medical bill, or even a temporary loss of income, life has a way of throwing surprises at us when we least expect them. That’s why having an emergency fund is so important. Think of it as your financial safety net, helping you handle these surprises without falling into debt or losing sight of your long-term financial goals.
If you're new to the idea of an emergency fund or just want to understand more about why it’s crucial, check out our article on What is an Emergency Fund? This guide will walk you through the simple steps to build your own emergency fund, so you’re always ready for whatever life throws your way.
Step 1: Set a Target Amount
Before you start saving, it’s important to understand how much you'll need to save in your emergency fund - this will be the target amount for you to aim for. This step will be easier if you are tracking your expenses and have a clear overview of your monthly expenditures. You need is to decide whether you want your emergency fund to cover only "needs" categories or if you need full coverage of your monthly expenses.
Monthly Expenses
Let’s say your monthly expenses are:
• Rent: $1,000
• Utilities: $150
• Groceries: $300
• Transportation: $200
• Entertainment: $100
• Total Monthly Expenses: $1,750
If you decide to save for only critical expenses, you can exclude Entertainment, reducing your total to $1,650.
Coverage Timeframe
The next step is to decide the timeframe you want your emergency fund to cover. This can vary from 1 to 12 months. Experts generally recommend saving three to six months’ worth of living expenses in an emergency fund.
If you decide to cover 3 months of expenses, your target emergency fund would be:
• $1,650 x 3 = $4,950
Now that you know a specific target amount and understand the nature of your expenses, you’ll have a clear goal to work towards and a better idea of how much you need to save each month.
Moneyscope has a built-in emergency fund calculator which helps you easily try different combinations with monthly expense categories and timeframes, giving you real-time recommendations based on your income and how realistic it will be for you to save the decided amount.
Step 2: Defining Contribution Amount and Frequency
Once you’ve defined your target amount for your emergency fund, the next step is to determine how you want to reach this goal, it can be a specific timeframe or you can decide to go with monthly contributions. The most important thing here is setting a realistic goal, to do this it’s important to tailor your contributions to fit your unique financial situation, including the type and frequency of your income. Here’s how you can approach this:
Assess Your Income Types: Whether you earn a regular salary, work freelance, or have a mix of fixed and variable income, understanding your income structure is crucial. This helps you determine how stable your income is and how much you can consistently set aside.
Determine Contribution Amounts: If your income is regular and predictable, you might opt for a fixed contribution each month. For those with variable income, consider setting a percentage of each payment you receive. This way, your savings contributions will naturally adjust to your earnings, reducing financial stress during lower-income periods.
Choose the Right Frequency: Matching the frequency of your contributions with your income can streamline the process. If you’re paid monthly, a monthly contribution might work best. For weekly or bi-weekly earnings, consider setting aside a smaller portion each paycheck to keep the savings momentum going without feeling overwhelmed.
Example 1: Realistic Plan
With a monthly income of $2,000 and living expenses of $1,750, you have $250 available each month to potentially save. If we recommend saving 50% of this available amount to avoid financial strain, that would be $125 per month.
To reach your goal amount of $4,950 with a monthly contribution of $125, it would take about 40 months, which is a bit over 3 years.
This timeframe allows you to build your emergency fund gradually without overstretching your budget.
Example 2: Unreal Plan
You want to reach your target amount of $4,950 in 12 months with your $2,000 income and living expenses of $1,750. In this case your monthly contribution would be: $4,950 / 12 ≈ $412.50 per month which is higher then $250 potential saving amount available each month.
By customizing the amount and frequency of your contributions based on your income characteristics, you can build your emergency fund in a way that feels natural and sustainable. This personalized approach ensures that you continue to save effectively, regardless of how your income fluctuates.
Step 3: Choosing Right Place to Save Money
How can I create an emergency fund if I am living paycheck to paycheck?
Building your emergency fund will require commitment, but focusing on a manageable approach can make it less daunting. Instead of fixating on the total amount you need to save, consider setting aside a small percentage of your take-home pay—whether that’s 1% or 2%. The key is consistency: save this portion each payday and make it a rule not to dip into these funds. Over time, even these small contributions will accumulate, steadily growing your emergency fund.
