5 Steps to building an emergency fund

1. Chart your expenses

To figure out how much you need to save, you first need to calculate how much you spend every month. As tedious as it may seem, it pays off to go over the past three months of bills to get a monthly average of your expenses. At a minimum, include:

• Mortgage payments
• Utilities, including bills for cable, Internet, landline and cell-phone service
• Groceries
• Insurance premiums, including home, auto and life. Add in at least $400 for individual health insurance - $1,000 for a family - in case the partner whose work provides it is the one to get laid off.
• Other car expenses including gas and loan payments
• Property tax (if not included in the mortgage payment)
• Discretionary spending Allow yourself some fun money. And be realistic: While there are certainly things like dinners out that you can cut back on in a pinch, don't delude yourself into thinking you can slash spending drastically.

Lindsay and Patrick calculate that their expenses are $4,750 a month. With only $1,000 in a savings account and a $1,500 buffer in their checking account, "we'd be through our savings before the month was out if one of us lost a job," admits Lindsay.

2. Measure your need

The rule of thumb is that you should have three to six months of living expenses in the bank. But your personal target depends on how stable your income is, says Tim Maurer, a Baltimore financial planner. With two salaries - which Lindsay and Patrick have - a three-month emergency fund may be sufficient in good times.

When finding a new job is tough, as it is now, it's a good idea to push that up to six months. If your family depends on a single income or if one or both of you rely heavily on commissions or bonuses, shoot for a six-month fund in safe times. And daunting as it sounds, aim for a year in uncertain times.

You can reduce the fund if you are guaranteed a severance package, but never dip below three months of cash - a lost job isn't the only potential emergency. Also, keep in mind that your fund may not be just for you. If your parents or grown-up children are likely to call on you in a crisis, you might need to tap your savings to support their emergency in addition to yours.

3. Find a place to put it

Often, the safest accounts offer interest rates that don't even keep up with inflation. "But the emergency fund isn't about yield," says David Greene, a financial planner in Fairfax, Va. Above all, you need an account that won't tumble in value and that's as liquid as cash.

Taxable stock and mutual fund accounts, while relatively easy to get at, fail the first test. When the economy is in trouble, chances are stocks are as well, making it the worst time to cash out.

The past six months have shown that home equity fails the second test. Lindsay and Patrick's HELOC is still intact. (Condo prices in Massachusetts are down only 2.6% year over year.) But since lenders have been changing the rules on HELOC equity, the Heinekes shouldn't view their line as guaranteed.

For the best combination of access, safety and yield, you have three options: a bank money-market account, a high-yield savings account and a money-market mutual fund. The first two have the benefit of being FDIC-insured for up to $100,000. And while money-market mutual funds are not insured, no individual investor has ever lost money in one.

Among these ultrasafe categories, pick the one with the highest yield. Go to bankrate.com to compare rates.

4. Build it up

Starting from scratch? Save fast. You don't want to be one emergency away from debt. Halt retirement savings - except to get your employer's full 401(k) match - and extra payments on low-interest loans until you have the target amount in the bank, says Maurer. Then resume retirement contributions.

Today, Lindsay and Patrick put $2,000 a month toward their 6% HELOC (they used $19,000 of their $38,000 line for home improvements and wedding costs). They could divert most of that to an emergency fund - still making $300 minimum payments on the HELOC. Combined with the $1,000 in their savings account, they'd be able to build a decent three-month cushion of $15,000 in nine months.

5. Look but don't touch

Once you've got the fund built, revisit it once a year and consider upping the amount if life events - like a new baby, new house or new salary - have increased your spending. Resist the temptation to use the fund for anything other than unbudgeted necessary expenses.

Hearing the planners' advice has made Patrick and Lindsay realize that they weren't as secure as they'd thought. They've decided to split their extra cash between their emergency fund and the HELOC, and they plan to move their savings from a bank account yielding a low 0.2% to a high-yield money-market account. Says Lindsay: "We've really had our eyes opened to how much risk we've had all this time."