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Emergency fund broken? Here's how to fix it

July 16, 2015

By Dan Rafter | Money Rates Columnist

Broken piggy bank

Don't have an emergency fund? Then you're asking for trouble.

What happens if your home's water heater bursts? What if your car needs a new transmission? Without an emergency fund, you might have to turn to credit cards to cover these surprises. And that's never a sound financial move.

It's why financial planners recommend that consumers build an emergency fund that allows them to cover between three and six months - ideally more - worth of regular living expenses.

"Most of our grandparents never owned a credit card," says Marie Vanerian, managing director of wealth management with the Troy, Michigan, office of Merrill Lynch. "They paid cash and tracked all of the money they spent. Our grandparents always took a percentage of their income and saved it for a rainy day. They always had an emergency fund."

Is your emergency fund today gathering more dust than dollars? Here's some good news: You can repair your ailing emergency fund. And it doesn't even take that much effort.

Start small

Staring at an empty emergency fund? Start small to rebuild it by cutting out excessive expenses.

Kimberly Foss, president and founder of Empyrion Wealth Management in Sacramento, recently worked with her daughter on this. The two calculated that Foss' 23-year-old daughter spent a whopping $1,814 per year on Starbucks coffee. Foss' daughter agreed to make her own coffee at home. And the money that she was spending on Starbucks? She's now depositing it into an emergency fund.

"Anybody can do that," Foss says. "Apply it to whatever you are buying too much of. Cut that down. Kick the eating-out habit, or at least eat out less often. You need to be aware of what you are spending too much on, and then you need to put that money into an account where you won't touch it."

Pay yourself first

Too often, people wait until the end of the month to contribute to their emergency funds, said Carolyn Dunlavy, owner of Jade Tree Retirement Planning in West Hollywood, California. But when they reach the last day of the month, they find that they don't have anything left to deposit.

"The key is a strategy called 'pay yourself first,'" Dunlavy says. "If you wait until the end of the month when the bills are paid and all the shopping is done, you find that you don't have much, if anything, to contribute to yourself because it's very easy to spend your paycheck down quickly."

Dunlavy recommends that you set up an automatic withdrawal from your paycheck that is deposited immediately into your emergency fund. Then you won't spend that money on anything else.

The numbers back this up. NACHA, an electronic payments association based in Herndon, Virginia, says that consumers who use direct deposit and automatic withdrawals tend to save $90 more every month than those who try to save their dollars manually.

Additionally, you could grow your savings by finding the best savings account rates for your deposits. 

"When it comes out the same day as your paycheck is deposited, you don't have a chance to see it, never mind to spend it," Dunlavy says.

Don't strive for a big tax refund

You might think that receiving a big tax refund from the IRS each year is a good thing. It's not: It means that you're sending too much money to the IRS each year. It's better to keep that money yourself. You might even invest that extra money into an emergency fund.

Michelle Dosher, managing editor of the Home & Family Finance Resource Center at the Credit Union National Association, says that if you are receiving a tax refund each year, it's time to submit a new withholding form to your payroll department. This will send fewer of your dollars each paycheck to the federal government. It will also leave you with a larger paycheck and a chance to put those dollars to better use.

"Put the extra cash into paying off bills and building your emergency fund," Dosher says.

A refinance can help

If you're paying off a mortgage or car loan, you might be able to save money each month by refinancing these loans to ones with lower interest rates, Dosher said.

Say you refinance your mortgage loan so that your payment drops from $1,500 per month to $1,200 per month. You can deposit the $300 extra that you've been sending to your lender into an emergency fund - a move that will allow you to refill an empty fund quickly.

"Unless you have credit card debt," Dosher says. "If you have credit card debt, put some of that extra money toward credit card bills."

Don't spend (all) of that bonus

Getting a bonus or a raise at work is certainly something to celebrate. It might also be an opportunity to repair your broken emergency fund.

Foss says that whenever you get a bonus, you should deposit at least half of it in an emergency fund. And if it's a raise? You should deposit at least half of the extra money you are now receiving with each paycheck into your fund.

"You've been living without that raise or bonus already," Foss says. "So you should be just fine with depositing some of it in an emergency fund. Take half and do whatever you want with it. Buy yourself whatever you want. Take the other half and put it into your emergency fund."

Keep at it

The biggest key to building an emergency fund? You need to be persistent. Even if you can't deposit much, deposit something. Financial planners say that depositing $50 at the end of the month is better than depositing nothing.

Don't let a big number - say your goal is to save enough to cover nine months of expenses - intimidate you.

"Don't get hung up on how big this number is," Dosher says. "Just steadily keep adding to your fund. By being persistent about adding to your fund, your savings will grow faster than you think."

Visit the savings section for more information the best savings accounts for your emergency fund.

Are you achieving your own emergency savings goals or have a long way to go? Share your progress in the comments.

More from MoneyRates.com:

Building an emergency fund

5 simple ways to build a rainy day fund

6 essential types of savings: When to begin each

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