Build your emergency fund on a saving account

After you optimized your budget, you should have started to have at least 10% of your net income available each month. The best first step to a better finance is to build your emergency fund.

An emergency fund is a reserve of money that will help you on dire situations. We are talking about the loss of your job or a debilitating illness; the emergency fund is not for a fancy expense like an 8K TV or the latest smartphone (you will need a separate saving for those).

Unfortunately such bad events cannot be planned, therefore it is important to have the resources available to cover for them.

This is part of the first steps on how to improve your finances.

As you can see on the title, I recommend to set the emergency fund on a saving account. You may wonder why not keep it on your main checking account; there are 2 reasons:

1. by not “seeing” the money on your main account, you are less tempted to spend them on unnecessary things;
2. while you are not spending those money, you will earn interests; and that will be basically “free” additional money.

Before you can build your emergency fund, you need to select a good saving account. At this moment I cannot provide you with a straight recommendation because:

• this blog scope is worldwide and each nation has different offers;
• offers change in time, so a specific account that is great today, may be beaten in few months by the competition.

But I can provide you with some general tips.

Select a saving account

A good saving account should have the following characteristics:

• it must have a clear fee plan; you don’t want to save for months to find out that you are paying more in fees (deposit, withdrawal, periodic, etc.) than you earn in interests;
• it should not have a time-locked policy; meaning that you should not be obligated to keep the money there for at least X months. As I said earlier, nobody can predict when an emergency will arrive; so you should not find your self unable to withdrawal those money when you need them;
• it should not have penalties for withdrawal; it sound similar to the above point, but in this case you could withdraw the money, but only after paying an heavy fee. Some saving account have penalties only after X withdraw in a year; in this case it is OK and you should just plan the withdraws accordingly.

Build your emergency fund

Once you have selected your account, you should set an automatic transfer from your main account. With an automatic transfer you will not risk to forget it or be tempted to skip one month.

If you receive your wage/salary by direct deposit, I recommend to set the automatic transfer on the same day or the day after; since your account will be at its peak in term of cash-flow, you will feel less impacted.

But there is an important question: how big the emergency fund should be? After all, after some point it would be over-kill, especially since there are other places where to put your money that are more lucrative (but more risky, therefore not appropriate for an emergency fund).

The general rule to build your emergency fund is to save the equivalent of 3-6 months of your net wage/salary. The specific amount will depend from the solidity of the industry you work in and the level of your skillets. If you work on a solid industry and you keep your skills current, you can be still safe with just 3 months of saving; on the other end if you work on a decaying industry or you didn’t upgrade your skills for a while, you should build a bigger emergency fund.

Build a secondary “expenses” fund

After you have reached your emergency fund goal, I strongly recommend a second saving account and put some money there.

Why? As I told you earlier, the emergency fund is only for very important expenses (living during unemployment, serious health issue, or other similar scenarios) and not for fancy things like a 8K TV or a sport car; also on the previous guide on how to optimize your budget, I recommend to not having bad debt (like credit card debt due to those fancy purchases). But I understand the temptation of buying such expensive stuff.

So the trick here is to save additional money for those expensive purchases and only after you have enough money, you can purchase them. And with this strategy you can have them without touching your emergency fund and on top of that you will earn some extra money via interests.

The future

Did you created your emergency fund (and eventually a secondary fund for expensive fancy stuff)? In the future guides we will see how to invest the extra money you are saving.