The last thing we want to deal with is an emergency, however, things happen.
Because of the unexpected nature of these situations, the best you could do is prepare in the little way you can.
Emergency funds have been proven to be the best contingency plan for these un-planned happenings.
But what is an emergency fund?
An emergency fund is a percentage of income that is set aside to handle unplanned and urgent expenditures. It is very easy to confuse an emergency fund for your savings. Though these two have a lot in common, they are not the same thing.
An emergency fund is a major component of your savings but is not the only thing that makes up your savings.
It is usually separated from your savings as it is dedicated to what people like to call “rainy days”. What does that even mean right?
The unforeseen expenses that an emergency fund can help take care of include medical bills, car repair bills, or repair of home appliances.
It can also cover car insurance deductibles and other expenses that we don't anticipate during an emergency.
In addition, the effects of periods of unexpected unemployment or loss of income can be cushioned with emergency savings.
Having an emergency fund means that you don't have to use your credit cards or dip into your roth IRA to fund these emergencies.
Reasons why an emergency fund is important
There are so many reasons why the popularity of emergency funds has not decreased over the years. Some reasons are explained in detail below.
An emergency fund will help in times of debt repayment.
It can help make up for the shortage in income you may experience while paying off that car or student loan. When needed living expenses captured in your budget can be taken care of using emergency funds.
This will help you focus on getting out of debt. It becomes a lot easier channeling that extra dollar when you know there is money stashed somewhere to cushion the effects.
In a situation where there is a single income stream, an emergency fund becomes very necessary.
Let's say you are a salaried worker or your business is your only source of income. Chance are you can really benefit from having an emergency fund. This is because, in the case of loss of a job or a setback in business, it can help you stay afloat while trying to fix things.
As a single-income family or individual, you may want to have an emergency fund that can cover a year's living expenses.
An emergency fund ensures you meet your financial goals.
You could be working towards a different financial goal at different stages in your money journey. It could be buying a house or even starting up a business.
With a good emergency fund balance, you can be sure that you wouldn't be dipping into your savings when unexpected expenses crop up.
The emergency fund, therefore, helps to protect your savings and ensure you meet your financial goals. Simply put, an emergency fund acts as an insurance plan which safeguards your savings.
You need an emergency fund if you own a home.
Owning a house, while it is desired by all, comes with extra expenses. The cost of repair and general maintenance could be quite high.
What most homeowners do is set aside funds that will be used in putting the house in shape.
However, some unexpected repairs may arise demanding that extra money be spent. An emergency fund may be your go-to at this point to lessen the stress of owning a house.
You are self-employed.
Being self-employed without having a good emergency fund is courting trouble on a rainy day. This is because a self-employed person may not always be able to claim unemployment benefits.
As a result of this, you may not have something to cushion the effect of a sudden loss of income.
This also applies to an independent contractor whose income may be seasonal depending on when a job comes. In that case, an emergency fund will help you maintain stability during the off-season until another contract comes.
How much should be set aside as emergency funds
There is no specific amount of money that would be considered right or wrong for an emergency fund. And you don't need a fancy calculator to figure out that magic number.
The right amount of funds to set aside is largely determined by the financial circumstances of the individual.
However, financial experts advise that emergency funds should be large enough to cover your living expenses for three to six months. This amount may be increased in a situation where it may be difficult to get a job replacement in a time of unemployment.
If your job is a seasonal one such that you may not be able to predict the flow of income, the above-stated rule of thumb may not apply.
Provision for an emergency fund, made at this point will have to be large enough to take care of more than six months of living expenses.
For a lot of people, setting a percentage of their money aside towards building an emergency fund may seem difficult.
However, the focus is not on the amount but on the fact that there is money somewhere to take care of contingencies. No matter how little it may be, start putting away funds now for eating day.
Ways of building emergency funds
#1. Envision where you want to be and come up with a specific plan
One of the keys to achieving almost anything is to have a picture of what you want, put it on paper, and work towards it. This principle also applies to building an emergency fund.
A plan is like a scale and a compass that helps to give a sense of direction and a basis for rating success. While setting a goal for an emergency fund, take into consideration the amount of income you have. Then decide the percentage of that income you would consistently commit to your goal monthly.
The aim of building an emergency is to start from somewhere and keep building up.
Don't wait. Start saving as soon as you can. Bearing that in mind, there is no need to put so much pressure on yourself by starting with an amount that may not be so convenient for you.
If money is tight you may not be able to pile up as much in the beginning. But, don't feel bad if the amount you are setting aside looks small at the beginning.
You can review the amount you are paying as more money comes in. Working with the bank to send weekly, bi-weekly, or monthly email reminders may help to create that consciousness of working towards a goal.
#2. Pay Yourself.
You may be wondering how paying yourself first will help stash some extra cash in your emergency funds. It's a way to automatically set aside funds. And by setting aside these funds they are out of sight out of mind which means that you are less likely to spend it.
One way you can do this is by setting up an automatic deduction from your accounts to deduct a specific amount of money to a high-interest account.
You can actually set this up with your employer where a certain amount or percentage of income is withheld from your monthly paycheck.
By setting aside this moeny you won't ever see it. And this amount when accumulated over time coupled with the interest it has earned will amount to something substantial. It also keeps you from the temptation of spending the extra money since you're not seeing it.
If it is not there then you can't spend it right?
#3. Downsize your expenditures
Taking the time to track your spending may go a long way to increase the funds that are available for emergencies. Doing this will help to keep you on track.
Going through your budget might help you find places where you can save extra cash.
When downsizing, what you will most likely be doing is trading off one expense for another. So, instead of eating out, you could decide to cook at home and save some bucks.
Constant shopping sprees may have to be replaced with planned shopping.
If you take out a little time to go through that budget again, you may discover some expenditure that can be removed.
The cash needed to build up an emergency fund may just be in that budget.
#4. Toss that extra change in a jar
This might be something you did as a child. So many children have saved hundreds of dollars by collecting spare change in the house.
However, when children grow up into adults, they abandon these habits.
Instead of using the spare change to buy things that you may not need, you can just toss them into a jar and allow them to build up.
Right now, the likely question may be: “How can I possibly build an emergency fund from this”? You may not be able to save millions from this but also realize that every penny counts.
Chances are that the spare change wouldn't even be missed so why leave it lying idle in your pocket.
#5. Introduce competition as a building strategy
For some people, an email notification from the bank may not be a strong motivation. If that is the case with you, consider getting other people on board.
It is easier to achieve a goal when working with other like-minded people. Look around your circle and pick out that friend or relative that can be frugal in spending and see if you can get them to come on board.
Imagine a scenario where you are competing with maybe your spouse in building an emergency fund.
Sounds like fun right?
There are no guarantees that you will get someone to come on board with you to create the competition needed to provide motivation.
Nevertheless, sharing your goals with your friend, spouse or relative can give you the extra motivation to keep working on those goals.
#6. Diversify your income source
Setting aside money consistently towards building an emergency fund can be quite a burden as a single-income person or house. The amount accumulated after some time may also not be so high.
Engaging in other side-hustles that can bring in a few extra bucks can help in relieving the pressure that may come with this.
Gone are the days when a single income stream can comfortably cater to all your needs with enough extra left for saving. Building a good emergency fund may require you to create another income stream which is difficult to do.
Working form home has become the normal trend has made it possible to do other things while still working 9 to 5 jobs.
Some of the side-hustles that have gained popularity in recent times include dog walking, Flipping, delivery services, virtual assistance, online tutoring, YouTube video creation, and selling of stock photos just to name a few.
The beauty of side hustles is that many of them do not require special training or skill to do. Also, some of them can be done from the comfort of your home once you are connected to the internet.
This gives you the liberty to set your working schedule and work as little or as much as is convenient.
#7. Don't spend that tax refund… Save it.
Do you have a tax refund coming your way? It could be tempting to spend that money on unbudgeted expenses.
However, that refund could be a rare opportunity to increase your emergency fund bank. So when you get a refund, stash it away in your savings account for a rainy day.
Where should you keep your emergency fund?
Remember that while it is important to build up an emergency fund, it should also be easily accessible.
It is therefore advisable to put the emergency fund into the money market account or a savings account.
The interest from the money-market or savings account may not be so great. However, they are preferred above others because of the high level of liquidity. Accessing funds during emergencies is made possible when the money is saved using these mediums.
Being in a separate account and not your checking account will also help in ensuring you don't use the emergency fund for daily expenditure.
Are you ready to start an emergency fund?
Starting an emergency fund can be intimidating. But it doesn't have to be.
With these steps you will be on your way to building that fund. And even with a few dollars here and there you will be surprised as how quickly that emergency fund adds up.
So are you ready to start an emergency fund?