Building your emergency fund

Have you ever had trouble setting aside money for a rainy day? You're not alone. 25% of people have no emergency fund and another 22% have less than 3 months of expenses saved up. That means that if a major emergency happens nearly half of Americans will end up going into debt. But how do you get started?

First, understand why

The first step in building an emergency fund is to understand why you need an emergency fund. Once you know why, understand that people develop their spending habits over months and years, so deciding to stop wasting money is akin to deciding to end an addiction. You have to have a plan.

Set Goals

Decide when and how much you want to save up so that you know how much you need to save each month. For example, say you decide to save up 1 month of expenses in five months. If you normally spend $2500 a month, then you will need to save up $500 a month to hit your goal. Be realistic with how quickly you can save up. It is better to choose a slow savings amount and hit your monthly savings goal each month than to miss your goal and get demotivated. If you know you can save up only so much a month, set your timeline based on that savings rate.

Limit recreational activities

Choose 1 expense you know you can eliminate, such as a meal out to eat, going to the movies, or some other recreational activity. The day you normally spend that money, instead put the money in your emergency fund account and spend the time doing something cheap or even free. Doing this over the course of several months can add up. For example, say you cut back eating out twice a month for a year where the meals cost $30 apiece. You will have saved up $720, just by slightly altering your spending habits.

Save windfalls

Many people file their taxes and get a substantial tax refund they can use toward building their emergency fund. If you receive a tax refund or some other relatively small windfall, use some of it for fun and put most of in your emergency fund. Take for example the average tax refund: $2,913. You could set aside $213 for fun and put the other $2,700 in your emergency fund. For many people that is a whole month of expenses and could allow them to stop living paycheck to paycheck and start tackling debt.

Pay off debt

Once you have 1 month of an emergency fund you can start working on paying off debt. The quicker you pay off your debt, the quicker you will be able to free up money that you can use to save towards your 3 months of expenses and eventually your six months of expenses. And whatever you do, stop borrowing more money.

Make it automatic

Most employers that provide direct deposit will allow you to direct deposit money into a savings account. The benefit of this approach is that you never see the money in your checking account, and as a result never feel the urge to spend it. If you are don't like the idea of not immediately having the money available, you could setup an automatic transfer shortly after payday. Making your savings automatic forces you to save and helps for the times when you would otherwise forget to save money.

Get a second source of income

Nothing helps build up emergency savings like having more money available to save, and a second source of income would provide just that. You could do anything from a getting a part time job, to selling your stuff online to tutoring students. The options are just about endless.

Sell your car

If you have a car with significant value sell your car and buy a cheap one. Doing so could help you add several months worth of savings to your emergency fund. If you have a car payment, get rid of it and buy a cheap one. Then use the freed up money each month to put towards your emergency fund.

Cut the cable

We did this and we have saved ourselves over $700. You may still be able to see many of your favorite TV shows and sports using just an antenna and free online services.

Use it only for emergencies

An emergency fund is for unforeseen emergencies, not for holiday decorations, vacations, prom dresses, or birthday gifts. Set up a short term savings account and put money aside each month for the things you know will come up. A little bit of planning will help you avoid dipping into and draining your emergency fund.

This is only a small sampling of ways to help buildup your emergency savings. What methods have worked for you? What didn't? Feel free to discuss.