An emergency fund is crucial because it is an account that will prevent you from going into debt in the future again. Without an emergency fund you’ll turn to credit to pay your unexpected expenses, rather than using your bank account.
Building your emergency fund is not easy and it can be harder sometimes to keep it and rebuild it. The important thing about an emergency fund to remember is that it is only to be used in the event of an emergency. While paying off debt is also important, I believe it’s more important to create an emergency fund first.
You don’t necessarily have to stop paying your debts just to build this account, but do it at the same time. One good strategy to building your emergency fund is to save up a certain amount (say $1,000) first. Then over the next year build that account up to three to six months of living expenses. Then the next year build it to nine months of living expenses. After this, maintain this account at that level.
Your emergency fund should be money that is easily accessible to you. In the event of an emergency you’ll need access to this money immediately. So don’t lend this money to anyone else, even if you’ll be paid back with interest. You will also not want to put this money in a CD (certificate of deposit) account either. Having the funds in an online savings account is acceptable, but keep in mind that it could take 3-5 business days to get the money back into your bank account.
Your emergency fund should not be cash and it should not be stored in your house. If you had a robbery, which qualifies as an emergency, you would have no emergency fund left. Likewise with a house fire.
You will want this money to be stored in a savings account, rather than a checking account. You need to keep this money separate from your main account. First of all you shouldn’t be tempted to use this money at all. Second of all, it might as well earn you some interest if it’s just going to be sitting there. And third, it will make it easier for you to transfer over extra funds from your checking account over to this savings account.