What do you dream about? Starting a business? Climbing the career ladder? A beautiful house? When we talk about our financial goals, what is often missed in the conversation is financial stability. The ability to live comfortably knowing we have everything we need and money in the bank, not necessarily chasing dreams.
What is an Emergency Fund?
An emergency fund is a pot of money you have tucked away in the event something unforeseen happens like a job loss, unexpected major home repair or money to tide us over like in the event of the recent Coronavirus pandemic.
It is hard to tell when such events will happen but you can cushion yourself from experiencing the adverse effects by building an emergency fund, which will give you peace of mind your family is protected and therefore improve the quality of your life. It can also prevent you from making costly financial decisions such as getting into more debt.
How to Build an Emergency Fund
Set Up a Saving Goal
The first step when building an emergency fund is to decide how much you need to save. Most experts recommend that you should save enough money to cater for your essential expenses for a period of three to six months. Setting up a saving goal will help you determine how much you need to save every month and how long it will take to build your emergency fund. Working with a goal in mind will also help you stay focused and motivated to achieve it.
If you earn a low income or if you have lots of expenses to deal with, building an emergency fund that should cater for three to six months’ worth of expenses can be intimidating. Instead, think about breaking down your saving goal into smaller miles stones. You can decide to start with a low target amount, then gradually increase your targets as you achieve them. The most important thing is to start now and be consistent.
Open an Emergency Account
Now that you know how much you need to save, the next thing you need to do is to open a separate bank account where you can put your emergency funds. The danger of putting money meant for emergencies in your normal day-to-day bank account is that some expenses that are not necessarily essential will crop up and you will be tempted to use the money. You can then choose to go for the interest-bearing accounts or those that have low or no charge.
When deciding where to put your emergency funds, keep in mind that the funds should be easily accessible. Emergencies often strike unexpectedly and, in most cases, require quick access to the cash. This, therefore, means that emergency funds should not be tied up in the stock market or bonds.
Automate Your Savings
To achieve consistency of saving into your emergency fund, you should automate your savings. Saving after spending your income does not always work because you can forget or you can use all your money to cover your expenses such that you are left with nothing to save. You can make arrangements with your bank to automatically make payments from your current account into your emergency account, just after you get paid. This way, you will train yourself to live within the remaining income and grow your savings progressively.
Budget and Track Your Expenses
The importance of budgeting for your income cannot be overemphasized. A realistic budget keeps your spending in check and makes you achieve your financial goals much faster. When you budget for your income, you are less likely to spend on the money you do not have therefore there will be no reason for you to access your emergency fund to cover for deficits.
If you have not automated your savings, ensure you incorporate the amount you want to save into the budget and set it aside first. You can then use the remaining income to budget for the other expenses. Review your budget regularly to decide which expenses to reduce and which ones to eliminate. Whatever you save from this, redirect it into your emergency fund.
Take a look at the 50/30/20 budgeting rule to get started with budgeting, it’s seriously simple to follow.
Save Any Unexpected Income
Having set up your emergency fund and putting in place proper action plans for building it, you can boost it further by saving unexpected income. When you get a bonus, cash gifts, or tax refunds, you can use a portion of each to build your emergency fund. If you have just paid off your debt, you can redirect the money you were using to pay the debt into your emergency funds such as minimum amounts you were paying for credit cards or loan repayments. The good thing with this is that your budget will remain the same, but your emergency fund will continue to grow.
How Much Should You Save In Your Emergency Fund?
It is generally recommended to have an emergency fund that can cover three to six months’ worth of expenses. However, the amount you put in your emergency fund can be lower or higher than this depending on other factors such as your level of income, job stability, health, and lifestyle.
For instance, if your job is relatively secure and you are guaranteed a regular salary every month, you can save three to four months’ worth of expenses in your emergency fund. On the other hand, if you depend on seasonal jobs or on and off gigs, you should aim to have six or more months’ worth of expenses in your emergency fund.
Similarly, if you are in a single-income household, your emergency fund should be higher than that of a person who is in a multiple incomes’ household. In addition, if you have children or other dependants to look after your emergency fund should be higher than that of a person who does not have dependents.
If you are relatively healthy and still in the working age, you can aim for a smaller emergency fund. However, if you have underlying medical conditions and you are nearing your retirement age purpose to have a substantial amount in your emergency fund.
An emergency fund acts like a financial buffer that keeps you afloat when you are faced with an unprecedented financial crisis. Building an emergency fund can take time and effort but having one in place increases your chances of achieving your lifelong dreams.