Why You Need to Start an Emergency Fund
What is an Emergency Fund?
An emergency fund is an account with money set aside for the specific purpose of an emergency. These unexpected events can be costly and can financially set you back if not prepared. Examples of such unforeseen emergency expenses include:
- Unanticipated medical bills
- Significant vehicle repairs
- Loss of a job
- Unexpected home repairs
In every case, these are unexpected costs, and being prepared with an emergency fund ensures that you can manage life’s unexpected events without having to worry about being able to afford those costs.
Why an emergency fund is Important
Emergency funds can help provide some relief in a time of need without resorting to taking out additional loans or going further into debt. When the Covid pandemic was widespread and the economy ground to a halt, the country went into a lockdown. During this time, many businesses were forced to suspend operations, and some businesses had to shut down as a result.
This shutdown of businesses resulted in many people losing their jobs and their primary source of income. And even though assistance was offered by the government, not everyone was able to qualify for it. Having an emergency fund in this situation would have helped families pay for living expenses while trying to get back on their feet.
How Much Should You Save in an Emergency Fund?
How much you need to save in your emergency fund depends on your financial situation, but essentially, you need enough to cover your living expenses for an extended period of time:
- Calculate your living expenses for 1 month. This includes how much you spend on mortgage/rent, utilities, groceries, and transportation
- Add 5% to the amount above for your target monthly amount (not necessary, but it provides a bit of extra buffer. So for example, if your monthly expenses was $2,000, you would end up with $2,100 as your target amount)
- Multiply this by 3. This amount will serve to cover your living expenses for 3 months.
A good rule of thumb is to have enough saved to cover 3 – 6 months of expenses. So start with 3 months, and aim to build up to 6 months of living expenses in your emergency fund. Some people have discovered the need to save up to 12 months of living expenses in their emergency fund, especially those in the freelancing industry
It doesn’t matter how much you initially start with in your emergency fund, the most important thing is that you start building it. This will come in handy because if you lose your job or fall on hard times, you can still use the money to pay for the necessary expenses while you find a new job.
A good rule of thumb is to have enough saved to cover 3 – 6 months of expenses.
How to Start Building an Emergency Fund
1. Calculate how much you want to save.
As discussed above, the rule of thumb is 3 – 6 months, but you can definitely go beyond that if you choose. This largely depends on your financial situation
2. Set a monthly goal to save.
Work on making saving a habit and it will become second nature. Deciding and budgeting an amount to fund your savings account monthly will help you stay on track.
3. Set up Auto-Deposits.
You can set up an auto-recurring deposit to your savings account whenever you get paid, so you are not missing any of your deposits.
4. Save Your Tax Refund.
If you happen to get a refund on your taxes, this is not money to splurge. Saving your tax refund can supercharge your emergency fund and help you reach your goal faster.
5. Review/Refill/Redeploy.
Review your account after a few months to see how much you have saved, and make any adjustments as required. If you recently withdrew money from the fund, you can use this time to assess how much is needed to get back to its original amount. If you find yourself in a situation where you have saved enough to reach your goal, you may want to consider redeploying the excess funds into an investment account.
Mark this Down – The Bottom Line
Although it can seem daunting when you first start building your emergency fund, you can actually meet your financial goal with the right approach. You will be happy that you did when you encounter a situation that comes with a large financial impact. You cannot rely on the government, or family, or friends to bail you out of a bad financial situation. The only person that is completely responsible for ensuring your financial stability, is you. You need to be prepared for the unexpected events that life throws at you. Having reserve funds specifically for this purpose can be the difference between minor financial turbulence or spiraling into debt.
