Building an emergency fund is an important part of financial planning.
An emergency fund is basically a bank account holding money that has been set aside to deal with unexpected expenses and financial emergencies. To ensure liquidity and ease of access, these funds should ideally be kept in a savings account.
Having an emergency fund gives you some wiggle room in the event of something unexpected happening that requires quick access to money.
Examples include things like:
- Losing your job
- Unexpected flights required in the event of a family emergency
- Medical expenses
- Car repairs
- The water boiler or some other major appliance breaking down
- Home repairs due to flooding or other reason
The idea of setting aside these funds exclusively for emergencies is so that you won’t need to have to rely on credit cards or loans to get you through these events, which can easily put you on the path to debt or push you into further debt.
The general recommended amount for an emergency is usually cited as a minimum of 3-6 months’ worth of expenses, but it is only a guide and many people will struggle to build that amount quickly.
Any amount is better than nothing, but a good starting point is around $1,000 or currency equivalent.
The question: How to get there?
The answer: Have a plan and stick to it.
How much you set aside each month for this purpose will depend on your circumstances and how quickly you want to cross this off your list.
Set a monthly goal, but I would suggest at least 10% of your total after-tax income if you can.
Remember that the emergency fund is for emergencies and you should never dip into it unless it really is an emergency situation.
If you don’t yet have an emergency fund or it is still below the recommended amount, consider some ways to fast track your way there.
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1. Sell something
Almost all homes are full of items that are no longer used, but could be sold for a bit of extra income. Common items include things like:
- Kids toys
- Unused electronics
2. Find a second job or side hustle
There are numerous side hustles you can do from home and online. A lot of these can be done in the evening and whenever you have time. However, be careful of a lot of the get-rich-quick claims made by bloggers and MLMs, as there are often a lot of half-truths and outright lies out there.
3. Reduce your spending
There are all kinds of places where you can reduce your spending. For example:
- Cutting out or even reducing the take-away coffees
- Buying cheaper brands of food
- Ditching subscriptions (gym, app services, etc.)
- Giving up smoking (double whammy here, as it is good for your health!)
- Switching to a cheaper mobile phone plan
- Saving you next salary bonus or tax refund
- Dining out less
- Saving spare change in a box/glass jar
Basically, do whatever it takes in the short-term to get you to the goal.
If you can, schedule regular payments from your current/salary account to the designated emergency fund account, so that the money doesn’t get spent elsewhere.
4. Track Your Progress
Check your progress regularly – either on a weekly or monthly basis. It is good practice to record your spending each month anyway and a good option is to use an app, such as HomeBudget.
You can read more about how to track your spending here.
If you’re falling behind target, the reviews will enable you to identify where and how you can improve and if you are on or ahead of target, seeing that will provide the confidence boost to repeat the success the following month too.
Where should you keep an emergency fund?
The whole point of an emergency fund is to have quick access to cash whenever you need it. Therefore, it needs to be liquid and the general advice is that the best place to hold it is probably in a low-risk savings account, which is pretty much any basic savings account you can get at any high-street bank.
Some people are concerned that they are wasting potential investment opportunities, but that is the trade-off for having money available for emergencies. It’s like insurance – people moan that it is a waste of money and if you never have to claim, it is really. But for that one occasion you might need it, it provides peace of mind and assurance.
If you invest your emergency money in funds, you have two potential problems.
Firstly, the fund needs to be sold and the settlement can take several days, which means the cash won’t be accessible until then. Even the most liquid of ETFs and stocks will take 3 days to settle and then you have to move the money to a bank account, which can take another day.
So if you sold your stock on a Monday, you could expect the money to be received in your trading account on Thursday, but you might not be able to get that cash from your bank account until Friday. In an emergency situation, that might prove to be too late.
Secondly, being invested in the markets, while giving your money the opportunity to grow, also means that it is susceptible to loss. This could present a situation where you have a shortfall in the event of an emergency. If, on the other hand, you keep your money in a savings account, at least you know exactly how much is available and that you can access it immediately.
Having said all that, I sometimes think this advice is a little dated, since there are other ways to hold liquid assets, such as a Visa pre-paid card or in your WeChat app, if you live in Asia. Ultimately, it doesn’t really matter, as long as it is remains safe and quickly accessible.
An emergency fund is an important part of financial planning that should not be overlooked, but a lot of people don’t have any kind of emergency fund and of those that do, it is estimated that less than half of all people have enough saved to cover any more than 3 months’ living expenses.
Don’t ignore the importance of having easily accessible cash available. It may seem a waste to have money just sitting there doing nothing, but think of it like a life buoy on a boat – if you fall into the sea, you might be able to swim back to safety without one, but it will be a lot easier with one.
How much do you have stashed away in your emergency fund?
Or do you think it’s not worth it? Let us know your views!