How To Build An Emergency Fund And Why It Is Important
This article is posted under Personal Finance.
Having an emergency fund is a necessity for everyone. It’s quite common sense to always have readily available cash for unforeseen expenses.
However, despite this fact, many do not have an emergency fund. And even if they do, it’s usually not enough.
I asked some friends if they have an emergency fund and fortunately, 6 out of 10 of them have one. Nevertheless, only 2 of them have more than one month’s worth of expenses saved. Which brings us to a common question about emergency funds:
How much money should you save and keep as your emergency fund?
There is no precise answer to this question. But it’s best practice to have at least 3 month’s worth of your usual monthly expenses saved. The optimal amount actually depends on the stability of your income sources. Single regular employees are usually good at 3 months but married professionals should consider having at least 6 to 12 months worth of expenses as their emergency fund.
I guess the most practical way to know how big your emergency fund should be is to answer the question: If you lost your job now or if your business closes down, how many months will it take you to find new work or start a new business?
An emergency fund is something we never really think about until the time comes when you need it. So spare yourself of the stress and avoid the unnecessary worries by building one as soon as possible.
One more thing, never think of your credit card as your emergency fund.
A few weeks ago, my car had some problems and I had to spend quite a sum for the repairs. My regular mechanic doesn’t accept credit cards. If I’d taken the car somewhere else that does, I believe I would have spent more for the same quality of work. This is just one example that proves that there’s really no substitute to having cold cash when you really need it.
So how do you build an emergency fund? There are five basic steps.
Step 1: You have to track your expenses. You need a comprehensive look at your monthly spending to determine your personal costs of living.
Step 2: Assess your needs. Evaluate your financial status and decide how many months should your emergency fund be.
Step 3: Decide where you’ll keep it. It usually best to open a separate personal savings account with ATM access for your emergency fund.
Step 4: Start saving. You can initially pay yourself first, then move on towards doing other money saving activities.
Step 5: When you reach your goal, continue saving and build it more.
I believe that the last step is very important. When you reach your goal, don’t stop and continue to build your emergency fund. There are a couple of good reasons why you should do this.
First, as time goes by, your cost of living increases – you get married, you have kids, inflation happens, etc. When these occur, your emergency fund should adjust accordingly. By continually adding more cash to your emergency fund, you can then confidently “upgrade your lifestyle”.
Second, your emergency fund can alternatively act as your investment fund. When very good opportunities come your way, you’ll have extra money that you can comfortably risk on an investment.
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Photo courtesy of Ed Yourdon
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