Emergency Fund: Why You Need It!Nov 20, 2020
No one knows when an emergency will happen, but when they happen, they are capable of derailing your financial stability.
I can testify to this when my parked car was crashed into by an unknown driver in 2018. This cost me an excessive amount of $400, which I did not have. I remember having to save for three months to afford repair costs.
I learned my lesson thereon.
A sudden home repair, an accident, illness, or job loss could affect your family’s daily cash flow if you aren’t prepared.
While emergencies can’t be avoided, having emergency funds can take the financial sting out of such events.
As useful as having an emergency fund maybe, some people find it hard to start one.
The office of Nation Statistics reported that as of 2019 the median household income in the UK was £29,600.
Despite the modest average income, there is an ongoing decline in the number of households who have no or very little savings to cover an emergency.
According to Money Charity, over 10 million households in the UK have no savings!
This means, more and more people are reliant on credit to get by.
What Is an Emergency Fund?
An emergency is a cash reserve or savings set aside specifically to offset expenses incurred in an unforeseen situation like medical bills, loss of income, home, or car repairs.
It is a nest egg, that should not be calculated as long-term savings for buying a car, paying college tuition, or going on holiday.
Instead, it is a fund that serves as a safety net in case of a financial crisis.
A Lot of people make the mistake of combining their emergency fund with other savings goals.
Instead, you should keep this separate as this money solely for emergencies and not a weekend away to Spain!
Well, considering we are in the heart of a pandemic, this may now be doing home renovations, because you are at home and bored!
If you don’t have an emergency fund you will find that going from one financial struggle to the other is likely to get you deeper in debt.
You may turn to credit cards and loans, but these only lead to debt that is harder to pay off.
How much Emergency Fund do I need?
When it comes to deciding on how much is the right amount for an emergency fund, this is usually a matter of personal preference and how long you are willing to save.
The right amount to put towards emergency savings depends on your situation.
For some people, consistently chucking away a certain percentage of your income every three or 6 months towards emergencies is fine.
There’s really no set time or amount you can save. It all depends on what you are comfortable keeping aside before situations that call for it arises.
However, keep in mind that you don’t want too little and it’s better to have more than needed.
Certain factors will determine how much you can put aside for an emergency fund - if you are married, have dependents, self-employed, or have health conditions.
Use this as a guide to calculate how much of an emergency fund you need.
Where Should My Emergency Fund Be Kept?
Emergency funds should always be liquid, which means you should keep it in a place where it is easily accessed when you need to draw on it.
The best place to keep emergency savings is in an interest-based account like an interest-earning savings account or money market that can be accessed without taxes or early-withdrawal penalties.
Mutual funds, stocks, or other assets may look like a good option for keeping emergency funds as your money can grow more.
However, they are risky as you may lose value, especially if you need to access the funds quickly.
To avoid this you want to keep savings separate from investing. You can find more about the difference between saving and investing.
When To Use Your Emergency Fund
The goal of tapping into your emergency funds is to cover expenses related to an unexpected emergency. Look at this as mitigating against risk, that might happen.
It is for priority bills such as needing a car repair like fixing brakes, buying a new battery or medical, home repairs, medical payments. In the case of the current pandemic, this would be making up for a reduction in income or job loss.
Remember that not every unexpected expense is a dire emergency, so don’t confuse an emergency for going on a shopping spree!
Nevertheless, don’t be afraid to use it when you need it.
How To Replenish Your Emergency Fund
When you draw down on your emergency fund, it will get depleted.
Don’t be hard on yourself, create a plan and start building it up again so that you always have 3-6 months of savings available at any one time.
Use these three tips as a guide on replenishing your emergency fund:
- If there are other goals that require your financial commitment, consider pausing them temporarily and begin to reallocate the money to your emergency savings to replace what you’ve lost.
- Create a repayment timeline that will help you get on track in building your emergency fund. So if you have spent £1000 on home repair, and you know you need to save £200 for the next 5 months, write it down and commit to it.
- Never leave out paying yourself first before life gets in the way. If you use a monthly budget, pay yourself first like any other bill, and list your emergency fund savings as a savings line in your budget.
- Ensure this fund is kept in a separate high-interest savings account so it’s not mixed up with your general funds and is accessible should you need it.
- Set up automatic bank transfer for payday so that you can be sure that at a certain day of the month your savings account will receive a given amount, helping to replenish your emergency fund
It’s a wrap
Think about this for a minute. Imagine what it’d feel like to have at least six months’ worth of expenses sitting pretty in an emergency fund in the bank.
I can see you smiling!
How would life feel for you? You will be able to breathe easier knowing that if any sudden situation comes up, you have that safety net in place to pull you through.
An emergency fund works like insurance - while it may cost you some money upfront, you can always be covered on rainy days.
With this picture in mind, you can see how important it is to start putting your emergency fund in place.
The earlier you start, the better you’ll get that sense of security. So next time a roof leaks, it will become an inconvenience rather than a crisis.
An emergency fund gives you the peace of mind that turns big situations to little inconveniences.
Also, having an emergency fund will help you avoid relying on credit or loans which turn into debt.