Living through the year of COVID-19 has taught us the importance of having an emergency fund. In 2020, we learned about how unpredictable life is and that we can never really tell what’s going to come our way. Emergencies can catch us off guard and put a dent in our financial capabilities.
What is an Emergency Fund?
Also known as a rainy-day fund, an emergency fund is money you save for unexpected circumstances. Your emergency fund is meant to protect you from financial distress and help you handle anything that life throws at you—whether that’s property damage, loss of job, business closure, and the like.
Emergencies may also involve a car accident, a trip to the hospital, or a shattered tooth—any event that will require you to spend money with urgency. A shoe sale isn’t a good reason to drain your emergency fund. These savings should only be used in the event of a true financial emergency.
An emergency fund can promote financial stability by providing a safety net that will allow you to cover unexpected expenditures. Emergency fund assets typically come in the form of cash or other highly liquid assets.
By using your rainy-day fund, you can avoid incurring high-interest debt, such as what credit cards or unsecured loans offer. An emergency fund also makes it easier to secure your future while leaving your retirement assets untouched.
Why do you need to save for an emergency fund?
The rationale for having an emergency fund is that finances can be unpredictable. If you lose your work or get into a car accident, you’ll be grateful you have an emergency fund to dip your hands into.
If you fail to prepare for emergencies, you may be compelled to buy into a credit card program or loan pitch since you don’t have enough funds to sustain your day-to-day expenses.
So, get some emergency money in order. You need that safety net to deal with life’s challenges.
How much do you need to save for an emergency fund?
Indeed, emergencies come in all shapes and sizes. They may be manageable, like getting a replacement for your tattered couch, or more life-threatening, such as suffering from a debilitating condition. The massive economic catastrophe and mandatory lockdowns from 2020 are also major events that threatened the financial freedom of countless workers, businesses, and retirees.
The ideal amount for an emergency fund is determined by several criteria, including your financial status, lifestyle, and priorities. Many financial gurus advocate accumulating enough money to cover three to six months of expenditures, which can help you weather a minor medical bill or a brief period of unemployment.
If one member in your family has a chronic medical condition that requires regular visits to the doctor or hospital, you should aim for a six-month emergency fund. Even if you have enough money in your monthly budget to cover the bills, it’s a good idea to be prepared in case of a major emergency.
How do you start building an emergency fund?
Putting money aside for emergencies will afford you a great deal of peace of mind. Here’s how to do it.
1. Create a budget and stick to it
A budget can tell you what you can accomplish regarding your saving goals. By making a list of your monthly income and expenses, you can determine how much money you can set aside for needs, wants, and emergencies. Ideally, your budget allocation for these categories should be 50%, 30, and 20%, respectively. You could download free budgeting tools to create a plan, organize expenses, and track debt.
2. Set a monthly savings target
This is the amount you want to set aside each month to add to your emergency fund. While it’s understandable it is not always easy to deduct from your salary and save the money for future use, you’ll be surprised at how quickly your savings may increase if you keep adding to it regularly! Don’t know what the appropriate amount is? Refer to step one and work on the budget.
3. Increase your earnings
If having a regular job does not work, consider taking on a part-time job. Look for a side hustle or start an online business from home. Nowadays, there’s no shortage of freelance work that can pay you on a per-project basis or for long-term projects. You could even consider babysitting your next-door neighbor’s toddler on certain weekends. Even the little things like this can help you accumulate extra income!
4. Readjust the amount you save
You can actually save more money as time goes on. If you or your spouse receives a promotion at work, you will be able to put extra money into your savings account. Develop the habit of reviewing your budget for new methods to tighten the purse strings and increase your savings.
7. Consider selling used stuff
Selling pre-loved items is one of the simplest strategies to boost your emergency money. Go through your garage or your closet to see what you can find. Is there anything you’d be willing to give up? Selling some of your rarely used belongings can help you build up a sizable emergency fund. Every little bit counts! You’d be surprised how quickly a few bucks here and there can build up.
8. Leverage your tax refund
Do you receive a sizable tax refund every year? Your tax refund is basically an interest-free loan that you give to the government all year, with the principal amount paid back to you in the early months of the following year.
Instead of spending your tax refund on purchasing items, such as new furniture or cool technology pieces, you may want to put the money in your emergency fund. What they don’t understand is that
9. Simplify it for yourself
You could automatically transfer from your payroll to your savings account to help you become a consistent saver. Some employers go a step further by directly depositing a portion of your paycheck into your emergency savings account.
10. Don’t allow debt to stand in the way
Saving money may be the last thing on your mind if you’re trying to pay off debt. Also, if you have high-interest debt, such as credit cards, it may make sense to pay down balances first. If your rates and balances are smaller and more reasonable, you can work on both goals at the same time: set aside money each month for debt and savings.
11. Evaluate and adjust your contributions
After a few months, revisit your financial strategy to see how much you’re saving and make any necessary adjustments, especially if you just drew money out of your emergency fund.
If, on the other hand, you’ve saved enough money to cover six months’ worth of bills and still have money left over, you could consider investing it to expand your income streams some more.
12. Raise the stakes
Once you’ve met your initial savings target, don’t stop there. Increase your savings goals gradually until you have enough money set aside to cover your cost of living for three to six.
Where should you keep your emergency fund?
When deciding where to put your emergency money, keep in mind that it should be liquid, which means you should make it readily accessible to you. To ensure that you won’t just dip into your emergency fund easily, see to it that your emergency fund isn’t kept in a spot where it’s too accessible, either. For instance, you can keep it in a bank account separate from your primary account.
It’s crucial to have your funds ready to pay your mechanic, doctor, or any other professional responding to your emergency promptly and conveniently. The following are your best choices.
- A savings account linked to your checking account, preferably with a high-interest rate and easy access
- Money market account with check-writing privileges or a debit card
- Online wallets you can use to quickly and directly move money from one bank account to another
When should you use your emergency fund?
It could seem like an emergency when an unexpected expense appears, but this isn’t always the case. Here are three considerations to ask yourself to determine whether you need to use your emergency savings:
- Is it essential?
- Is it unforeseen?
- Will it be a priority?
If you answered yes to these three questions, that tells you your circumstance is indeed an emergency and that spending your emergency savings is reasonable.
The Bottom Line
An emergency fund is similar to insurance in that it costs money upfront. Then again, this fund can protect you and your loved ones should things go wrong. Make a budget, pay down debt, and start saving. You’ll be amazed at how rapidly your emergency fund grows. What’s even better? You’ll have an incredible sense of safety.
Indeed, there’s a sense of relief that comes from having your emergency fund kickstarted, allowing you to reduce a major crisis to a slight inconvenience. It’s high time that each one of us gets educated on how to manage our finances appropriately, starting with building an emergency fund.