1. Build An Emergency Fund

Your first savings goal is to build up an emergency fund. This is a buffer of liquid cash to handle unexpected expenses. The amount in the fund should equal about three to six months' worth of expenses; if you spend $40K annually, you'll want $10K–$20K in your emergency fund.

The purpose of the emergency fund is to handle unusual circumstances: you might lose your job, your car might break down, or you might suddenly need to fly home. The emergency fund cushions the rest of your finances from the messiness of real life. You might think of it as a form of self-insurance! By maintaining an emergency fund, you can avoid taking on credit card debt or incurring early withdrawal penalties from retirement accounts when disaster strikes.

Since emergencies are inherently unpredictable, keep your emergency fund somewhere readily accessible. A dedicated savings account is a good choice. Online-only banks tend to offer better interest rates (I use Ally, personally, which currently offers 1.2%), but any bank account should do.

Don't invest your emergency fund in stocks or bonds! It's important to minimize risk. Your money needs to be immediately accessible when you need it, and we definitely want to avoid volatility. If the market takes a down turn you may have to sell at a loss.

While you're building up your emergency fund, continue making minimum payments on any loans. Don't pay more than the minimum, even on high-interest credit card debt. Building and maintaining an emergency fund should be a higher priority than aggressively paying off loans. Without an emergency fund the next catastrophe will force you to take on more debt, trapping you in a cycle of high-interest payments. Break the wheel: save up a cash buffer.

Once you've saved up an emergency fund, don't use it for anything except emergencies. Maybe you'd like to save for a down payment, or for a nice vacation? Don't spend that emergency fund! Suppose that, after buying a house, you find that the roof needs to be repaired. If you had spent your emergency fund on the down payment, you'd be in a pickle. To avoid inadvertently confusing your savings goals, you might want to keep your emergency fund in a separate savings account.

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