How to build an emergency fund even when you think there's nothing extra in your budget

You know you need a cash cushion.

But the numbers can be daunting. Experts say you need three to six months of living expenses — or even more.

If you're put off by the numbers — how do you save when you can barely make ends meet? — focus on simple steps.

The first is to get started on reducing any debt, says chartered financial analyst Leslie Thompson, managing principal of Spectrum Management Group at Carson Wealth in Indianapolis.

Next, work on saving up your cash reserve.

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Part of the goal is not the money itself. "It's building up the discipline to save money," Thompson said. Set up auto-save through your bank. Most major banks and credit unions offer such features.

If you have nothing saved and think higher levels are impossible, set a lower goal, like $500 or even less.

The way to get there is by saving consistently. Remember: Any amount, no matter how small, counts. Regularly setting aside $5 is better than not saving at all. 

One way to conceptualize a savings goal: Take your largest monthly expense, whether rent or your student loan, and work toward that amount. When you've achieved that, double it.

Boilerplate advice can be demotivating, says Priya Malani, a founding partner at financial planning firm Stash Wealth in New York. Her firm has been pushing against the conventional standards for emergency funds for some time.

People frequently recommend saving a fixed amount, such as $10,000, or a few months' of living expenses. These rules of thumb may not work for everyone, Malani says. Instead, she prefers fine-tuning these guidelines.

"Your emergency fund should equal three months' of your fixed expenses," Malani said.

These are different from your living expenses: They're the things you cannot turn off immediately if life is suddenly upended. "You should include regular pet care and child care in your fixed expense numbers if you pay them every month," Malani said.

If your emergency cash need isn't too great, you might be able to fill in the gap with a side hustle, says Vicki Salemi, a career expert at Monster.com in New York.

Gig economy work is easier when you're younger. You have fewer financial obligations, Salemi says, so scout what you need to earn between jobs and see what you can cut, such as a gym membership. Make sure to account for health insurance premiums if you are not still on your parents' plan.

Younger millennials and Gen Zers may not need as much as six months' living expenses, Salemi says. 

They might be able to stay with friends or move back in with their parents for a while in case of a job loss, where people in their 50s might have a mortgage and college tuition to pay. That makes the need for emergency savings more critical.

If you need motivation, imagine a situation — health care or home problems are most common, Thompson says — where you need cash but don't have it.

If it's a health crisis, people can often negotiate with the hospital for a reduced amount and an installment plan to pay off the balance. But other situations might not be that flexible.

You might have to work out something with a contractor or a vendor, if it's a house-related bill, Thompson says. "Otherwise, people tend to fall into credit card debt, which is not great."

Though far from ideal, she suggests considering a loan from your 401(k). Most plans do offer loans, though some do not. If you need money for an issue related to Covid-19, you can take a distribution without penalty, thanks to the CARES Act, if you are younger than 59½. 

"Emergencies come in all different shapes and sizes," Malani said. Some can be fixed with extra pocket cash from a quick stint with a gig job and others can't. She has seen clients whose pets were diagnosed with cancer and needed chemo treatments right away.

It might be easier to frame your savings decision as a percentage of income. "Instead of saying you need $10,000 in savings, it would help to say ideally you should be saving 10% of your income," Malani said. "It's more digestible and therefore motivating."

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