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12 Tips for Building an Emergency Fund

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saving for a rainy day

One of the most common pieces of financial advice you'll ever hear: Start an emergency fund. Like insurance, storing money in an emergency fund can seem counterintuitive. In the best-case scenario you'll never use it, but in reality, we rarely get through life without an occasional crisis. Being prepared financially can prevent a small problem from turning into a complete financial disaster.

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set a short-term goal

It's easiest to work towards a goal when you have an exact target in mind and can track your progress. If starting an emergency fund seems overwhelming, reframe the objective as a short-term cash reserve of $500 to $1,000. That's a reasonable goal and sufficient to cushion the impact of small emergencies.

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build for the long haul

Once you've reached the short-term target, keep things rolling. The standard advice is to sock away three to six months' worth of expenses in an emergency fund, perhaps more during tough economic times. Figure out how much you spend every month -- include expenses for rent, food, household supplies, utilities, and transportation, and then factor in miscellaneous costs such as vehicle registration, insurance payments, annual membership dues, and so on.

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open a separate account

Your rainy-day fund should be in a low-risk and easily accessible account. The money should not be invested in the stock market; the intent is not to earn a return but to have cash on hand when the need arises. Some people prefer to keep their emergency fund in a separate account to resist the temptation to spend it on everyday needs and to keep tabs on how much they've accumulated.

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build a money ladder

Individuals seeking a higher return on their money might consider creating a certificate of deposit (CD) ladder. CD investments are not liquid, by definition (the money is available at the maturity date), but a CD ladder lets you divvy up the assets among CDs of different maturities, which gives you access to some amount of cash every three months. If you want a year-long rainy-day fund, for example, hold three months of expenses in cash and park the other nine in a CD ladder.

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track your progress

Use a personal finance application like Mint, YNAB, or Personal Capital to track your expenses and savings progress. Looking at the big picture every week or month will reveal additional sources of savings.

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use your tax refund

You shouldn't rely on a tax refund to feed your emergency stash because there's no guarantee you'll receive one. That said, most taxpayers qualify for a refund, which averages nearly $3,000. If the government does return some money, devoting that to your emergency fund is a painless way to start or top one off.

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let technology be your friend

If you have trouble putting money aside, let Digit analyze your spending habits and automatically move money into a Digit-run savings account -- when you can afford it. This is a hands-free way to save, and the account is insured by the FDIC. There are no fees and you can withdraw money quickly, whenever you want. The catch: Digit keeps the interest earned on your savings as payment. (The site is well-reviewed by finance bloggers.) Given how low interest rates are right now that's not much of a price to pay for mindless savings.

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ignore your next raise

Next time you get a raise, act as though you you didn't. Have one nice dinner out to celebrate and then stick to the budget already in place. Put the extra money towards your rainy-day fund and you'll be saving without noticing any changes in your day-to-day life.

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lower your fixed expenses

Look for ways to lower monthly or annual expenses. Try to negotiate the price for your Internet, cable, and home phone services. Compare insurance rates, gym fees, and mobile phone packages to see if a different provider might be cheaper. Put the savings you uncover into your rainy-day account.

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become a freelancer

Sometimes the best defense is good offense. Instead of looking for savings opportunities, try to find ways to earn a little extra money. If you have any experience as a writer, programmer, designer, marketer, or personal assistant, freelance marketplaces like Guru, eLance, and oDesk have plenty of jobs available. Often these are project-based or short-term arrangements, letting you work enough to build the emergency fund and then stop if you want. If you have handyman skills or don't mind doing yard work or dog walking, advertise your services on Craigslist and around town with flyers.

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what's an emergency?

When should you dip into the emergency fund? The definition of emergency varies from person to person, but does not include the latest high-tech watch (even if it's on sale); unexpected job loss, a medical crisis, or a family emergency certainly qualify. If your car or a major home appliance breaks, that's also a good reason to dip into the fund, although some proactive budgeters consider these foreseeable events and budget accordingly.

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earn bonus points

Once you've built your emergency fund, use the same tactics to contribute to a tax-advantage retirement account -- a 401(k), 403(b), or IRA -- and give yourself a few bonus points for smart life planning.