All this week we are going into detail on each of my four steps to financial freedom.  Yesterday we talked about the different strategies for paying off debt.  The next step in my financial journey is to build an adequate emergency fund.  Today I will show you how to quickly and easily set one up.

But before we discuss how to set one up, let’s make sure we are clear on what an emergency fund is.

What is an emergency fund?

As we talked about last week, an emergency is the life jacket in your boat.  It is there to protect you from life’s unexpected expenses (and your life will have plenty of them). 

Last month, the brakes on my car started squeaking.  What I expected to be a minor expense turned into $450.  Had I not had an emergency fund in place, I would have had to either take money from my investments or use debt to pay this expense. 

An emergency fund is a savings account you keep separate from any other accounts.  It’s an account you only use for unexpected expenses.  An unexpected expense is not a last minute trip to Cancun for spring break.  It is a necessary expense that you haven’t saved or budgeted for. 

Here is my advice for starting an emergency fund quickly and easily:

Choose an online bank with a high yield savings account

Why an online bank?  While it is not something most personal finance experts think is necessary,  I recommend an online account for several reasons:

  • It is extremely easy to setup:  Instead of going to a local bank to wait in line and fill out lots of forms, you simply go to a website, put in your information, and your account is up and running.
  • It is harder to withdraw money on a whim:  Since you actually have to go in and transfer money from your online account to your local bank account in order to use it, you are less likely to take it out for anything other than necessities.
  • It is easy to set up-and change- automatic monthly deposits to fund it: Instead of having to go into your bank every time you want to make or change an automatic deposit, you simply log into your account and you are done with a few clicks.
  • Easier to compare and find top rates: Unlike banks in physical locations, you aren’t restricted to the number of banks in your immediate area.  With the internet, you can use a bank half way around the world just as easily as you can use one from your hometown.  And with more competition comes better rates.

Here are some of the top online accounts to choose from:

If you are not comfortable using an online bank, a local bank will work just fine.

Decide how much you need in your fund

There is not a set amount that every expert agrees is the ideal balance in an emergency fund.  Some think you should keep the least amount possible in and use the rest of your money for more lucrative investments.  Others feel you should have a years worth of living expense.  The majority seem to fall into the three to six months worth of living expenses range.  As with everything else in personal finance, it depends on your situation.  Here are some questions to help you decide how much to keep in yours.

  • Is your job at all unstable?
  • Do you have a family that depends on one income?
  • Is your income commission or incentive based?

If you answered yes to any of these questions, you probably need at least a six month emergency fund.  If not, you can probably get by with more of the three month range.  It is important to be honest with yourself and expect the unexpected.  When in doubt, error on the side of too much.

Begin funding the account

After deciding on an adequate amount for your emergency fund, it’s time to begin funding it.  Choose the highest amount you can live without each month and have it automatically deducted from your checking account into your online bank account.  By automating the process it will be harder for you to skip out on monthly contributions.

After you reach your pre-determined amount, you can stop contributing to the account. 

Example

Now that we have covered each step, here’s an example of how to start an emergency fund.  For this example I’ll use my online bank, ING Direct.

  2. Click on “Open an account” on the left hand side.
  3. Choose the very first option, “Orange Savings Account”.
  4. Click “Open Now”.
  5. Fill out application.
  6. Enter your checking account and routing numbers in order to deposit money.
  7. After your account is opened, click on “automatic savings plan” and choose the day and amount of money you will be transferring to your account each month.
  8. Continue plan until your goal amount is reached.

That’s it.  You’re done.  The entire process should take you less than twenty minutes.

An emergency fund is one of the biggest keys to building wealth.  It helps keep you out of debt and can be a huge stress reliever during times of financial turmoil.  By following the simple steps outlined above, you can have your fund up and running in no time.

Tomorrow on Centsability to Wealth we will discuss IRA’s and the difference between a 401k and a Roth IRA.  Please continue sending any questions, tips and story ideas to centsabilitytowealth@gmail.com

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