Basics: How to start an emergency fund

A few of my close friends are reading my blog and have asked me: "How do I start my emergency fund?"

My first answer was: "Simple. Just open an online savings account and transfer money each paycheck."

I realized that most of these people are not used to saving money at all. I neglected the fact that someone trying to get on track financially for the first time might not know how to start logistically. Guys: This post is for you!

If I were starting an emergency fund today from scratch this is what I would do:

  1. Open an online savings account at ING Direct (or other online bank of your choice). Ask me for a referral so we both get the account opening bonus money!
  2. Roll/Deposit all your coins at your local bank and transfer it to the above savings account.
  3. Set up an automatic transfer of $20 (or more if you can afford it) per paycheck to the new savings account. Analyze your monthly budget to get your exact figure.
  4. Calculate how much your total monthly essential expenses are each month. This only includes the money you need to live like rent/mortgage, food, utilities, insurance, etc.
  5. Multiply above number by 6. This is your target amount for your emergency fund.
  6. Deposit any extra income, tax refunds, etc. into your emergency account.
  7. Once you hit your money target you are done. Continue saving for other goals or stop the automatic savings transfer and add the same amount to debt repayment.
  8. Review your emergency fund each year. Did your expenses change? Do you need to add more to it to maintain your 6 month's worth of expenses?
If you follow all of the above steps you will have set up and maintained your emergency fund. Having an adequate emergency fund is the only way we can weather all the bumps that life throws at us. Unemployment, health problems, house fire, and many other situations can come up and this is our own form of insurance.

If you ever have to tap into your emergency fund remember to go back to step 2 and replenish the money as soon as you can. An emergency fund works only when we keep it funded at all times.

Side note: If you are self employed you need a 12 month emergency fund.