5 tips for building an emergency fund

By Holly Johnson

We've all been there. Your dryer breaks down. Your car needs new brakes. You finally have to replace your leaky roof. These are just a few of the common costs that can appear out of nowhere to drain your wallet. So what are you supposed to do when these unwelcome surprises occur?

You can't predict the future and there's no way to safeguard yourself against the many external factors that cause emergencies. However, there is one fool-proof way to prepare for a lifetime of unexpected expenses: start an emergency fund.

We've talked recently about what an emergency fund is and why it's important to have one. But if you haven't done it before, creating an emergency fund can seem like a challenging endeavor. Try using these five tips to get started.

1. Identify regular saving opportunities

In order to free up cash to divert to your emergency fund, you may need to cut some of your expenses (assuming you can't find a new way to make extra money). Take a look at where your money is going and evaluate if it's all completely necessary. Do you really need cable television? Is there any way to reduce your utility bills? Maybe you're eating out at restaurants too often. Once you determine what you can cut, you can start tucking that new-found cash away in your emergency fund.

2. Start small

The thought of setting aside several months of living expenses can see intimidating. But luckily, it doesn't have to be saved all at once. You just have to make the decision to get started and find the best way to start stashing away some cash. Some possible ways to begin include making weekly or monthly contributions until the account reaches your desired level. Small amounts can add up quickly when contributed on a regular basis.

3. Use windfalls to your advantage

It's tempting to use a windfall, such as a tax refund, to buy something you've always wanted. However, it's much smarter to move unexpected sums of money into your emergency fund. Any windfall, big or small, will help move you that much closer to your goal.

4. Guard against false emergencies

Your emergency fund should only be used for legitimate emergencies. Don't look at it as an extension of your available cash, and don't spend it on things that aren't completely essential. If you ever doubt whether you should tap into your emergency fund, ask yourself if what you're planning to spend is for a "want" or a "need." Essential car repairs, medical bills and some job-related costs may all count as true emergency expenses.

5. Find the right account

One of the best ways to keep your emergency fund at an adequate level is to put it somewhere "out of sight, out of mind." An easy way to accomplish this is to stash your emergency money in an online savings account. By keeping it in a separate account, it's less likely to be used for non-emergencies. A small amount of Internet research should help you find an online bank that offers competitive interest rates.

I've built my emergency fund. What's next?

Once your emergency fund is big enough to cover several months of expenses, you can start saving for other goals. You could take the money you've been setting aside and put it away for retirement, your kid's college or a vacation fund. The choice is yours. But now that you've got an emergency fund, you can worry much less about unexpected bills knocking your finances off track.