Building Your Emergency Savings

Creating an emergency savings fund is critically important to your financial future. The point of the fund is to create savings that match between 3 to six months of your living expenses. This money can be used in emergency situations, such as having to support yourself and your family in times of unemployment, or if an emergency situation arises. What's key is that you consistently put the money away, and then use it only for true emergencies. Different than an investment account, the success of a long-range savings plan counts less on the rate of return than on putting a set amount of funds away consistently, and always having instant access to it.

Putting it away
People maintaining disciplined budgets will have the most difficult time putting away money for the proverbial “rainy day.” But simply finding an extra $45or $50 each month to put in a separate emergency savings account is very much worth doing. To do this, experts recommend treating the savings fund as another bill.

If you decide you need about $3,000 your emergency cash fund, look at what you can afford to put away every month, and pay yourself as if it’s a bill. If it’s $75 or $100 a month, just keep making the deposits every month and the fund will grow. When you have saved the complete $3,000 you will now be used to saving that extra $75 or $100 every month. The best advice then is to keep saving it, but now deposit the money in an investment, retirement or college savings account.

It can be very difficult to money aside by yourself. Many retirement plans are successful because the funds are pulled directly out of your paycheck before it’s available to you, and also due to the significant taxes and penalties levied for early withdrawals. But an emergency fund requires easy access, and keeping cash in an available account like that requires discipline.

When the money is available there are certainly many demands -- the mortgage, taxes, holidays and so on. You may consider limiting your access to the emergency to some degree. You need to have instant access to some of the money, but perhaps not all of it.

As the emergency account grows, think about keeping part of it in a money market fund about two months of living expenses are covered. When that happens you may consider moving one month worth of expenses to a one-month CD. When the CD matures, roll both the principal and interest into another one-month CD. Continue to make payments to your emergency fund money market account. Soon you will have yet another month of living expenses and can then invest in a two or three month CD.

Paying yourself first
Regardless of your financial situation, the first step in creating an emergency fund is finding out just where your cash is currently being spent. Experts say that most people don’t have an accurate idea of where their money is going. It helps tremendously to use a cash management tool such as Quicken to keep track of where your payday checks are going.

When you understand where your money is being spent it can be much easier to decide where you can trim expenses. If you have any concerns about job stability, it becomes even more important to build your emergency fund as quickly as you can. Loaning yourself money from your 401(k) account is usually not a smart move. If unemployment strikes, you might be required have to repay the loan immediately, or make good on the taxes and penalties from the money withdrawn.

Loans from your IRA account also must usually be repaid in a short timeframe. One action that may you might consider if you’re well away from retirement age is suspending payments to your retirement account. It’s better to have have three to six months cash reserves on hand than to borrow against your 401(k).

Only consider suspending your contributions as a measure of last resort. When you cease 401(k) payments you do lose out on tax-deferred growth and may even be losing up a matching employer contribution. Pulling from any retirement fund for emergency cash should be avoided unless there are no other options.

Budgeting Tips
You’ve heard it before, but it still rings true: stop using those high interest credit cards. Unless you almost always pay off your credit card balance each month, a good rule of thumb is to not use the cards for purchases you can eat or wear.

Other suggestions for budgeting that should work for almost everyone:

At the present time, mortgage rates are very low – you might think about refinancing your mortgage and perhaps your car loan as well.

If the city you live in has excellent public transportation, see if you and your spouse can manage with only one car. Make your present car last as long as possible. Think about trading in or replacing your current car in six to eight years rather than every three years.

Look at ways to reduce your energy bills at home.

Families should consider eating in restaurants less often. Also, if you buy coffee and a bagel out every morning, make it at home before you leave. You’ll be amazed how fast $5 a day adds up.

Learning to save money on your own takes some discipline but it does get easier as it becomes a habit. Knowing you have reserved some financial resources for that rainy day buys considerable peace of mind, and makes the sacrifices now well worth while.