Purpose of this article: to define the emergency fund and help you put together a plan to increase yours.

Bullet Point Summary

Building an emergency fund to cover 3-12 months of expenses will take time
Focus first on saving $1,000 as soon as possible
Commit to saving all windfall payments you receive like tax refunds or any year-end company bonuses
Over the long-term you will need to spend less to save more and look to make more income overall
Building a good budget that helps you cut back on spending will be key
Save any yearly raise received. 1% to 3% can add up quickly
Rinse and repeat until you hit your goal

Overview

Ask any financial planner and they will tell you that an emergency fund is a must. Some will suggest you save upwards of three months of expenses while others will tell you one full year. In this article we discuss the ins and outs of the emergency fund and conclude by giving you strategies to boost your emergency funds.

What Are Emergency Funds For?

The ultimate point of the emergency fund is to set aside cash to cover your most basic needs during an unexpected life event. We all have differing wants and desires in life, but our basic biological requirements for survival are the same. When push comes to shove, we need air to breathe, food and drink, a place to lay our heads at night, and clothes to wear, as depicted in Maslow’s Hierarchy of Needs:

Consequently, an emergency fund needs to be established to cover unexpected financial situations like the eviction from an apartment, loss of a job, medical bill, or temporary disability to name a few. In these situations, you’ll need immediate access to cash to cover your most basic expenses and needs while you get your financial situation back on track.

Is There a Right Number?

In a 2018 article, CNBC found that only 39% of Americans had enough savings to cover an $1,000 emergency. Defining the “right number” for an emergency fund is hard because financial emergencies by their very nature are unplanned and their lengths unknown. Instead, we suggest thinking through some of the larger types of unexpected life events that could cause you to dip into your emergency fund and planning specifically for those:

Loss of steady income from primary job – it takes roughly one month per $10,000 you make to find job per thebalancecareers.com. So a person making $50,000 a year would need at least five months of income saved up (roughly $21,000) to tidy themselves during their job hunt.
Major medical expense – the average emergency room visit can cost $1,200 to $2,200 without insurance. Other hospital costs like X-rays and surgical procedures can average over $3,900 with hospital stays costing over $15,000 without insurance. And these days it feels like there is no upper bound on medical bills even with insurance.
Car repairs and maintenance – depending on the severity of repair, costs can range from $300 for a water pump replacement up to $3,000 for a transmission replacement.
Major household repairs – similar to car repairs the cost of household repairs will very with the severity of the repair. An new HVAC system can cost 3,800+ while a new roof can run into the tens of thousands.

Using these four large unplanned expense, we build the following table to give you suggested savings targets at differing levels of income:

These savings targets are simply estimates and provide months of coverage ranging from 6 to 12 months. The most important thing is for you to see how expensive unplanned emergencies can be and start actively saving for them.

Short-Term Steps to Build Your Emergency Fund Over Time

It will take time to build a robust emergency fund with three to twelve months of expenses. With competing interests like saving for retirement and paying down debt, it can be difficult to find the extra cash needed to build your emergency fund. The following are the first couple of steps you can take in the short-term that will allow you to build temporary cushion for emergencies.

Your first step will be to save $1,000 as soon as possible. As we mentioned above, only 39% of Americans had enough savings to cover an $1,000 emergency. By focusing here, you are giving yourself a tangible goal that will help give you real cushion against any financial emergencies in the short-term. Set up an automatic transfer from your checking account to an online savings account like Ally of at least 3% of each paycheck. Someone making $40,000 would have over $1,000 in one year:

This assumes that your emergency fund doesn’t accrue any interest which isn’t the case especially if you put your funds in an Ally online savings account. As of the date of this article 5/22/19 Ally’s interest rate on their online savings account was 2.20%.

Your second step will be to save all windfall payments you receive like tax refunds or any year-end company bonuses you may receive. In the past tax refunds had averaged close to $2,100, but this year that was down to about $1,950. Even still, you should put this injection of cash directly into your emergency fund and get one step closer to peace of mind.

These steps are meant to help you build a temporary cushion for emergencies in a short amount of time. Once you complete these steps you will switch your focus to paying down debt if you are not debt-free. And once you are debt-free you will refocus on aggressively building a more robust and complete rainy day fund to cover three to twelve months of expenses.

Long-Term Steps to Build Your Emergency Fund Over Time

It will take time to build a robust emergency fund with three to twelve months of expenses. You should view view building enough emergency savings as a long-term project that will get easier as you free up more cash from the burden of life’s expenses.

Over the long run it will be important that you do two things very well: (1) spend less to save more and (2) make more income. As simple as this may seem, these two factors are the key to building your emergency fund in the long-run.

In order to spend less you will need to build a good budget that helps you cut back on spending. Knowing exactly how much you spend monthly will be key and we suggest using a digital app like Mint or You Need A Budget to track your expenses. The ultimate goal is to bring light to your monthly cash inflows and outflows which will help you free up funds to accelerate the growth in your cash reserves.

Boost your savings by bringing in more income through a side hustle or part-time job even if only temporarily. Make sure to save any yearly raises received. The average pay raise is around 3%, so a person making $40,000 would have an additional $1,200 to save towards the emergency fund over the next year.

Continue to execute the short-term and longer-term strategies discussed above until you hit your goal of three to twelve months of emergency savings.

Conclusion: Remember It Takes Time

An estimated 530,000 families go bankrupt each year because of medical issues, so it’s clear that medical expenses are a big unplanned life event. On top of unplanned medical expenses, there are a ton of other life events that happen unexpectedly that can derail your longer-term financial plans.

The only way to ensure that you will be truly financially secure in times of crisis is to build a robust and well-padded emergency fund. It takes some real time and effort to build a robust enough emergency fund that can handle three to twelve months of expenses, but it’s absolutely doable. We hope the strategies detailed within this article will give you a good enough guide to start building your emergency fund.