Life always comes to us with challenges, most come as major emergencies that need you to set up an emergency fund. There may be unexpected events such as having to fix up your car when it develops a fault or taking an unexpected trip, or it may even be an unplanned expense for school.
In any of these cases, if there was a reserve fund, navigating these unexpected circumstances would have been easier, which is the case for emergency funds. In this article, we will walk through how to build an emergency fund and give tips on how to keep the fund robust.
What is an emergency fund?
An emergency fund is a reserve set to cover unexpected financial emergencies that may arise from time to time. The fund helps cushion against unforeseen events without having to having to resort to high-interest debt or liquidating investments. Life emergencies come in different forms, popular examples are listed in the table below.
| Unforeseen Expenses | What it means |
|---|---|
| Medical Emergencies | Unexpected healthcare costs such as accidents or sudden illnesses. |
| Home Repairs | Urgent repairs for unexpected issues like plumbing leaks or electrical problems. |
| Car Repairs | Unplanned expenses for fixing vehicle breakdowns or damages |
| Job Loss | Loss of employment leads to a need for financial support during the transition. |
| Legal Expenses | Unexpected legal fees or costs associated with unforeseen legal matters. |
| Travel Emergencies | Sudden travel requirements due to family emergencies or other unforeseen events. |
| Education Expenses | Unanticipated costs related to education, such as tutoring or exam fees. |
| Pet Emergencies | Veterinary bills for unexpected health issues or emergencies involving pets. |
| Appliance Breakdowns | Costs associated with repairing or replacing essential household appliances. |
| Natural Disasters | Expenses resulting from damage caused by unforeseen natural disasters. |
| Family Events | Unexpected financial obligations arising from family events or celebrations. |
| Technology Repairs | Unexpected costs for repairing or replacing electronic devices or gadgets. |
| Homeowner Association Fees | Unexpected fees or assessments imposed by homeowners’ associations. |
| Car Accidents | Costs related to accidents, including repairs, medical bills, and insurance. |
| Identity Theft | Expenses associated with resolving issues related to identity theft or fraud. |
Benefits of having an emergency fund
An emergency fund provides an anchor for your financial life, its mere existence will allow you to invest wisely and timely, as you don’t have to eat into your investments or take on debts to address the unplanned expenses but specifically, the benefits of creating an emergency fund include:
- It allows one to make sound decisions in times of turmoil: Having a reserve during an emergency will deter you from making bad financial decisions. Yes, there may be other ways to access cash, but at what cost? Interest, fees, and penalties? It also deters one from breaking into investments when not mature or making investment decisions emotionally.
- Building financial discipline: building an emergency fund allows one to foster discipline, as it cultivates the ability to prioritize saving and budgeting, imparting valuable skills crucial for prudent money management.
- A remedy for financial anxiety: Just knowing that there is a stash of funds somewhere helps ease financial anxiety.
How do I build up my emergency reserve?
There is usually no set amount for what an emergency fund should carry. However, the idea is to grow slowly and preserve the purchasing power of the fund. You can preserve the purchasing power of the fund by investing in very liquid assets like money market instruments so that when the need arises, the fund can be easily liquidated. Remember, the goal is to be able to access the fund when needs arise so, no sophisticated investing can be done with the fund. Here is a step-by-step guide to building an emergency fund:
Create a budget
Budgeting will help you map out how much of your income can go to the emergency fund. The exact amount varies based on your circumstances such as dependents, employment status, and access to additional financial support. However, you should aim to save enough to cover three to six months of living expenses. Remember, there is no predefined amount that should be saved, create your budget and work with what is available.
Start with Small Contributions
If you don’t have a substantial amount of cash readily available, initiate regular contributions to your emergency fund. Set up direct debits, even if it’s a modest amount like $100 per month, to steadily build your fund over time.
Scan through your savings account and choose the right one
You should opt for a basic savings, high-yield savings account, or money market account so the funds can be easily accessible. Prioritize safety and liquidity over high returns. Avoid investing in stocks or bonds where your funds may be exposed to market risks. Remember, the goal is to be able to preserve the value of the fund while still maintaining a level of separation to deter impulsive spending.
Reserve Funds for True Emergencies Only
Strictly limit withdrawals from your emergency fund to genuine emergencies such as unexpected car repairs, sudden job loss, essential home repairs, or significant medical bills. Resist the temptation to dip into the fund for non-urgent expenses or discretionary purchases.
Replenish and Maintain
If you do need to use funds from your emergency fund, make replenishing it a priority. Treat unexpected expenses as a reminder to review and potentially increase your emergency fund target to better prepare for future uncertainties. Recognize that unexpected expenses can occur in clusters, so it’s essential to continuously evaluate and adjust your emergency fund strategy as needed.
Final thoughts….
Emergency funds are very beneficial as they prepare you for unexpected events. Thus, incorporating them will help provide stability and security. prioritizing the establishment and maintenance of an emergency fund is a fundamental aspect of sound financial planning. By diligently saving and managing these reserves, individuals can safeguard their financial well-being and weather unforeseen challenges more effectively.
FAQs on Emergency Fund
1. What is an emergency fund, and why is it essential?
An emergency fund is a dedicated savings account set aside for unforeseen expenses like medical bills, car repairs, or job loss. It provides a financial safety net, reducing reliance on high-interest credit cards and loans and alleviating financial anxiety during crises.
2. How much should one save in an emergency fund?
Financial experts recommend saving three to six months’ worth of expenses initially, with higher goals for sole breadwinners or those with variable incomes. Start with small, achievable goals, like saving $10 a day, and gradually increase the reserve to cover several months’ expenses.
3. Where should I keep my emergency fund?
The ideal location for an emergency fund is a high-yield savings account offering easy access and competitive yields.
4. Can my emergency fund cover only specific expenses?
Your emergency fund should encompass a broad range of expenses, including housing, utilities, transportation, food, and essential debt payments. It serves as a versatile resource to address various unforeseen circumstances, offering financial stability and peace of mind.
5. How often should I reassess my emergency fund strategy?
Regularly evaluate your emergency fund strategy based on changes in income, expenses, and financial goals. Replenish the fund after withdrawals and adjust savings goals to align with evolving circumstances.
