How to flip the "debt snowball" strategy to build an emergency savings fund fast
If you're in debt, two of the most popular payoff methods include the "debt snowball" and "debt avalanche." These payoff methods focus on debt balances and interest rates to help you build momentum while paying off debt.
The debt snowball and similar methods are great for paying off debt, but you can flip the script and use a similar strategy to build your savings and investments. This works for emergency funds, which are particularly important as we continue to navigate financial challenges during the COVID-19 pandemic.
If you're looking for ideas on how to improve your savings, try the "savings snowball" method to build an emergency fund and more.
What is the debt snowball?
The debt snowball is a debt payoff method for people with multiple debts. The basic idea is to sort your debts by balance and pay them off from smallest to largest while paying only the minimum on all debts outside of the primary target debt. With a focus on your budget, you can squeeze the maximum cash from your monthly income to put towards your target debt.
Like most things in finance, you can use a similar formula for a very different purpose. If you like the idea of a system like the debt snowball for paying off debt, you can follow a similar system to build up your savings.
Flipping the debt snowball to build your emergency savings
If you want to use the same idea as the debt snowball for your savings, it's important to list out your savings and investment goals (more on that in the next section). Once you have those in place, you can put your own "minimum payment" into each account every month while focusing extra effort on one primary goal.
For example, let's say you are saving for an emergency fund ($5,000), a new car ($15,000), and a down payment on a home ($25,000). You can use a savings snowball to funnel money into all of them at once.
To start, you can choose your own "minimum payment" amount, maybe $20 per goal per month. That's $60 per month in savings. In this case, the emergency fund should be the main priority, so any extra savings you can afford go to that account until you reach your goal.
Once you have your $5,000 saved in the emergency fund, you can stop adding $20 per month there and put any extra savings you can afford into the car or down payment fund, whichever you care about most. Once that goal is reached, you can stop putting $20 per month towards that goal and funnel all of your savings into the last goal.
You will notice that as you reach each goal, you can save more and more each month for the other goals. Interest from your savings accounts (or investments) can help you get there a little bit faster as well.
Watching your progress toward your goals every month — while one moves even faster — should help keep you motivated to save and reach those big goals.
Automation and interest can lead to a savings snowball
One of the best parts of the debt snowball is the ability to start small and build your contributions up over time. If you can stick with a savings snowball for at least a few months, you may be able to build a lifelong savings habit that helps you reach longer-term goals, like saving for retirement.
Many people who don't have an emergency fund might feel like saving hundreds or thousands of dollars is impossible. It's OK to start small, even with $1 per workday. Over time, those $1 contributions add up.
As you save over time, interest from your bank will help your savings grow even faster. While interest rates might be low, every little bit counts! Ideally, you should have at least three months of expenses in cash in a savings account for emergencies.
For a very short-term plan, you can save for emergencies in your checking account or a general savings account. Ideally, however, you eventually have enough savings to support a dedicated emergency savings fund, which is best kept in a high-yield savings account in most cases.
Planning for your emergency and long-term savings avalanche
Here is a suggested order of savings to build a safety net and reach other longer-term goals as well.
- Basic living expenses in your checking: According to a survey by Magnify Money, over half of Americans live paycheck to paycheck and 70% couldn't keep up with bills after just one missed pay period. If you struggle to pay for groceries and other bills, start by making sure you have enough cash to cover about a month of expenses in your checking account.
- Dedicated emergency fund: Once you have a little breathing room and padding in your checking, you can start your savings snowball by funneling cash into your dedicated emergency savings account on a regular schedule. If you get any lump income from a tax refund, gift, bonus, or large commission, try to save the entire amount.
- Retirement savings and tax-advantaged investments: Once you've hit your savings goal in your emergency fund, you can stop adding to that account but shouldn't give up on your savings habit. Start funneling funds into 401(k), IRA, HSA, and other accounts that offer tax advantages.
- Other goals: If you have a stable emergency fund and are making regular contributions to retirement and other long-term investment accounts, it's OK to turn your savings snowball to other goals. That can be things like a home purchase, car purchase, big trip, or general savings in a taxable investment account for goals you have not picked yet.
Clearly, putting food on the table and covering immediate expenses like rent and utilities should come first. But once you've met those basic needs, you can cut back on other parts of your budget to grow your savings rate.
Start your savings plan even if you have to start small
If you feel like it's not worth saving unless you can put away $20, $50, or more at a time, think again. Even small savings add up over time.
If you can save $1 per weekday, that adds up to about $20 per month, or about $240 per year. If you can increase that to $5 per shift, that's going to give you about $100 per month or $1,200 per year. Saving $10 per workday will give you about $200 per month in savings and $2,400 in annual savings.
Those savings rates won't help you reach your emergency fund goal overnight, but you will get there if you stick with it. Building good habits and funneling as much of your income as possible into savings will pay off with a lifetime of interest, dividends, and financial stability.
This information is provided by Voya for your education only. Neither Voya nor its representatives offer tax or legal advice. Please consult your tax or legal advisor before making a tax-related investment/ insurance decision.