Are you prepared for when life throws you a curveball? It could be losing a job. And as a result, you may find yourself struggling to pay your bills. Or it could be a health emergency, or you need to get your car fixed.
Wouldn’t it be great to know that you have a buffer against a potential life crisis?
Personal finance experts agree that everyone needs an emergency fund in place. Think of it like a safety net. And with life’s unpredictability, it’s crucial to prioritize your emergency savings.
An emergency fund is simply the money you’ve stashed away for life’s unexpected events. It serves as a buffer to help you stay afloat in case of financial distress. It helps cover expenses so you don’t have to rely on loans or credit cards.
This savings account is reserved for true emergencies such as:
- Unforeseen medical expenses
- Major home repairs
- Major car fixes
So buying the newest cell phone model or walking past a sale doesn’t qualify as an emergency. Save your emergency fund for the true rainy day!
But what if you have insurance for the emergencies listed above? That’s great! The insurance can cover the bulk of the expenses. However, you might still find yourself in unexpected circumstances like loss of income. That said, having an emergency savings bank account should be a priority.
While emergency funds won’t solve all your financial problems, it’s a great start. It’ll give you a head start in the right direction.
How much you set aside for your emergency fund depends on a few factors. Take a look at your financial situation. For example, how stable is your income? If you’re part of a two-income household and have a steady job, then a three-month emergency fund may be enough.
But according to financial experts, a 6 months worth of emergency fund is a better idea. This is advisable for individuals with an unstable job, or who have a chronic medical condition, or have outstanding credit card debt, and so on.
Starting early is the secret to setting up emergency funds. Doing so will help you build a comfortable cushion against emergencies.
Take a look at the table below. It’s a simple breakdown of the basic expenses of Mr. Chu, who’s in his 30s, has a stable source of income, and is renting a one-bedroom apartment:
|Food and Transport||$400|
So a $16,000 ($2,750 x 6) emergency fund can sustain Mr. Chu.
Each individual’s monthly expenses vary. The goal is to ensure that you can still continue living life comfortably without bringing in income.
Saving a certain amount can be overwhelming. The easiest way to build an emergency fund is to make them a part of your budget. Set aside a certain percentage of your pay every month.
First, calculate your monthly living expenses and income. By doing so, you’ll determine how much money you have available. You can then set the desired portion for your emergency savings.
How do you determine your emergency fund goal?
Create a table similar to the one above. This will help you have a clear view of your basic living expenses. Once you have the total, multiply it by 6 months. That’s how much you’ll need to save.
Some people stick to a barebones emergency fund which can cover enough to pay for their basic necessities. While others prefer to have a savings fund that can cover luxuries. It’s up to you to decide how much you want.
As mentioned above, you need to have a monthly savings goal. You can take out a percentage of your pay every month. To help ensure that you save every month, you can automatically transfer funds to your savings account.
For example, if your salary is deposited directly to your bank, you can divide your paycheck. You can set it up so that a portion will directly go to your savings accounts. In doing so, your monthly goal will always be met.
Feeling intimidated? You can start small, around $500 to $1,000. A smaller goal is easier to reach. Plus, it gives you a sense of accomplishment once you’ve reached a small milestone.
Don’t treat your tax refund as extra cash you can spend on unnecessary purchases. Instead, save it. Doing so will boost your emergency funds. To avoid the temptation of spending it, consider having your refund deposited directly into your emergency savings account.
An emergency can strike at any time. That said, your emergency funds must consist of liquid assets, mainly cash. Additionally, you must have quick access to these funds.
For this reason, it shouldn’t be tied up in stocks, bonds, or mutual funds. Although stocks offer long-term growth potential, their value can suddenly decrease. So don’t be tempted to use your emergency funds for these investments. You might end up with nothing when a real emergency happens.
The best thing to do is set up a separate savings account or checking account. In doing so, you won’t be tempted to take out money for frivolous expenses. Consider high-yield savings accounts. Your money will earn interest over time. Most importantly, you’ll have easy access to cash when you need it.
It can be challenging to determine when and how you’ll use your emergency savings. That said, you need to decide what constitutes an “emergency” situation. Here are a few instances:
- Loss of income: This is a huge financial emergency. Use your rainy day fund to cover essential living expenses like food and housing.
- Unexpected medical bills: This can lead to stress and financial distress. Your health insurance can cover the bulk of it. But you might still need to tap into your emergency fund to reach your deductible.
- Repairs: If the roof leaks or your car breaks down, you’ll need access to your emergency savings to pay for these unexpected expenses. This is a better option than using credit cards.
- Pet surgery: Surgery on animals can be costly. If your furry friend gets a serious illness, you could be facing a huge medical expense. Combining your pet insurance and your emergency fund, you can easily pay for these costs upfront.
Ask yourself what will happen if you don’t pay the expense. Will it get you in trouble with the law? Will you end up with more debt? Will you face bankruptcy?
For example, you have financial obligations that need to be cleared. The longer you put it off, the more debt you accumulate. It may not seem like an urgent matter, but after a few months, you might find yourself in financial distress. That said, pay it off using your emergency fund.
Got a loan you can’t repay? Think before you default on a loan. It can seriously hurt your credit score. That said, use your emergency savings funds to pay off the loan. Even if it will cause serious damage to your savings, do it before your debt snowballs.
No one knows when life will throw a curveball. That’s why everyone needs to save for emergency situations. This safety net can mean the difference between weathering a short term inconvenience or going deep into debt.
Get on a budget. Pay off your debt. And if you have multiple debts, you can opt for a personal loan. Then you can use your emergency funds to clear off your balance.
So start your emergency fund today. Saving up six months’ worth of expenses can give you peace of mind. Think of your emergency fund as insurance. It may cost you money monthly, but it will cushion the blow of unexpected expenses.