How to start an emergency fund

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Q. My new year’s resolution is to start an emergency fund – and not spend it. Do you have strategies I can use?
— Want to save

A. An emergency fund is a great resolution.

These accounts are a critical element of a sound financial plan.

In order to meet your resolution, you first need to understand your current cash flow, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway.

He said the best way to do this is to create a budget by looking at all your sources of income and all expenses.

“I suggest looking at your checkbook and credit card statements for the last three months to capture all recurring and non-monthly items,” he said. “You should try to capture cash expenses as well, because those daily lattes can really add up. You may be surprised by the results.”

McCarthy said this step accomplishes a couple of important goals: it identifies your fixed and variable costs versus discretionary spending, and it establishes your monthly cash flow need, which helps determine how large your emergency fund should be.

Fixed expenses include housing (rent or mortgage), and insurance (home, auto, medical, life), McCarthy said. Variable expenses include food, clothing, transportation and utilities.

Discretionary spending would be everything else, he said.

“Fixed expenses can be reduced but not easily. Variable expenses can be controlled with diligence and planning — shopping in bulk, bringing lunch to work, turning lights off and heat down when not at home, etc.” McCarthy said. “Contact utility providers and inquire about going on a `budget’ plan, which levels out your utility costs monthly. Any reduction in your monthly costs can be added to your emergency fund.

Don’t forget to look at ways to increase your take-home income, McCarthy said.

As example, take a look at your last income tax returns.

“If you got a big tax refund, that may mean you’re having too much withheld from your paycheck,” McCarthy said. “If that’s the case, you can reduce your withholding by changing your W-4 at work, which may increase the cash you have throughout the year to add to your emergency fund.”

He said the goal is a balance between owing little or no tax and to get a small or no refund when you file your income tax returns. You should consult the appropriate professional as information provided should not be construed as legal or tax advice.

McCarthy said generally three months of your monthly cash flow needs is the minimum you should work towards. Depending on how stable your income source(s) is, you should consider setting aside up to six months of expenses.

To find the right place to stash your emergency fund, you can open a savings account at an online bank with FDIC insurance, said Sheri Iannetta Cupo, a certified financial planner with SageBroadview Financial Planning in Morristown.

“You don’t want to make it too easy to access so don’t open it at a bank where you have your checking account,” she said. “Assign a nickname to it that motivates you to not spend it.”

She said you should make it fun to save by rewarding yourself with a small treat when you achieve milestone savings goals.

In addition to finding ways to trim your spending, you can use other opportunities to build your account.

Cupo said you should make savings automatic. You don’t want to have to decide each week whether to spend or save so divert a small amount from your income each month to build savings.

“If you get a raise – or receive money unexpectedly — rebate, coupon, gift, refund, garage sale — send it to savings,” Cupo said.

When you do have a true emergency, give yourself permission to use it, she said. But when the emergency is over, start to rebuild the account.

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This story was first posted in January 2016. presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.