Most of us prefer not to think about crises. After all, who wants to dwell on what-ifs like job loss, car trouble or medical bills?
But living only in the moment can, and all too often does, backfire. More than 60 percent of Americans don't have enough cash saved to deal with even minor financial setbacks.
That's where having an emergency fund comes in. Setting aside money for things like a job loss or an unexpected tax bill can save your finances from going under. Experts recommend starting small. Then, over time, grow your savings to a year's worth of expenses, suggests Ryan Brown, partner at CR Myers & Associates.
"Obviously, this depends on the person," he says. "If you're single, this number will be lower; if you have children, the number may be higher."
Here's how to get your emergency fund started, step by step.
1. Define "emergency."
"For one person, an emergency may mean a flat tire or not being able to pay the electricity bill," says Syble Solomon, creator of Money Habitudes, a tool that helps people confront their subconscious attitudes about money in order to make progress on their finances. "For another, it may mean losing a job. Be clear about what is and is not an emergency."
If you're the kind of person who could use a reminder in the moment, consider writing out your emergency guidelines. Later, that could make it harder to convince yourself that buying a new work outfit is actually an emergency.
2. Understand your expenses.
How can you know how much you're able to save if you don't know how much you actually earn? "When you're trying to establish an emergency fund, you must first evaluate your budget," says Ron Adams, co-owner of Retirement Solutions. If you don't have a budget, he adds, now's the time to make one.
Start by listing your monthly expenses, like utilities, mortgage or rent, groceries, and loan payments. Next, estimate your periodic costs, like holiday gifts, annual renters insurance and seasonal expenses. (You can use Credit Karma to track your expenses all in one place.)
Then, compare your spending total to your income. Are you operating at a deficit? Do you have money left over?
3. Know your savings goal.
To arrive at the total you'll want in your emergency fund, tally up your average monthly expenditures, including seasonal and irregular expenses, and multiply by the number of months that you want the fund to cover. Let's say you spend an average of $2,000 a month on rent, food, transportation, health insurance, clothing and everything else. A three-month emergency fund would be $6,000, while a six-month emergency fund would be $12,000. The totals may sound high, but they'll also be powerful -- wouldn't it be great to know that you could survive six months without an income and still be okay?
Once you've identified how much you want to save, start with a small amount and increase it as you go, says Pamela Capalad, a Certified Financial Planner™ who runs the company Brunch & Budget.
Sometimes savers set unreasonable goals. "I totally get why," Capalad says. "The beginning is exciting, and you want to see results fast. But often, that means you can't cover your expenses comfortably, and you end up dipping into the savings and feeling defeated."
If you're struggling to get started, Solomon suggests dumping the change from your pockets and purses into a large change jar every night. "It adds up," she says. "Soon, there will be $100 that you can use to start an emergency fund."
Brown suggests dedicating 10 percent of your paycheck to emergency savings.
But if you think you can't spare that 10 percent, start looking for unexpected room in your budget. "Chances are, you have more money available than you think," Adams says.
4. Open the right kind of account.
Multiple experts emphasize that your emergency fund should be separate from your regular savings or checking accounts.
"If your emergency savings are in the same checking or savings account as your day-to-day money, it'll be much harder to avoid using it," Solomon says.
Stashing away money also doesn't mean letting it languish. Consider growing your emergency fund passively by looking for a high-yield savings account that pays as much interest as possible. Before opening an account, read the fine print and check for minimum-balance requirements or fees associated with the account.
5. Make it automatic.
Setting up automatic contributions -- either through account transfers or an automatic paycheck deduction -- can make saving easier.
This is in part due to something called "loss aversion."
"We are hardwired to avoid pain and seek pleasure," explains Solomon. Instead of moving money you already have to an emergency fund, try saving the money you haven't actually touched yet. Because of loss aversion, it can be less painful to deduct a percentage of your paycheck before it hits your account than it is to contribute the same amount after you've gotten your hands on it.
6. Pay down your debt, and free up your budget.
Paying off credit cards can go a long way toward freeing up space in your budget; the money you save by nixing high interest payments can far outweigh the returns on any savings investment.
That said, it can be dangerous to maintain nothing in savings while paying down debt. "I've seen clients who put every dollar toward paying down debt and aren't saving at the same time," Capalad says. "Then, when an emergency comes up, they end up needing to put it on a credit card. Their debt goes back up, and it feels like a never-ending cycle."
Capalad says you should first make sure you have at least three months' worth of expenses in savings, then focus on paying off your credit cards.
7. Keep it up.
You're not totally off the hook once you've created your emergency fund. "Once you've reached your goal, you need to leave it alone," says Adams. Maintain your list of what constitutes an emergency so you'll be able to distinguish when something isn't a financial crisis.
After that, Adams says, "Just keep yourself up to date with the balance. You'll need to know how much you have available in case that emergency ever arises."
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