In today’s uncertain economy, it is wise to look at your savings and whether or not you have an emergency fund set up in the case of unplanned expenses, or large-scale emergencies such as job loss or a major natural disaster.
What Is an Emergency Fund?
One of the keys to good financial planning is preparing for the future, whatever it may bring. This means having an emergency fund. An emergency fund covers a financial shortfall when an unexpected expense arises. Your emergency fund can be a place to get the money you need when you find yourself facing a large expense you weren’t expecting.
To improve your investment returns, it is wise to have both a short-term emergency fund and long-term emergency fund. A short-term emergency fund is your go-to when you have an immediate emergency ensuring using an easily accessible account with a debit card attached. This would be used for smaller emergencies, such as car repairs or replacing a major appliance that breaks. It can also be used as a bridge to get you through the few days until you can access your long-term emergency fund.
A long-term emergency fund allows you to save for large-scale emergencies, such as job loss or a major natural disaster like an earthquake or fire, and earn a slightly higher level of interest. You could also choose investments that take a few days to liquidate, as long as you have a short-term emergency fund to cover you in the interim.
When you have an emergency fund, you have peace of mind. Even if your emergency fund isn’t big enough to handle everything, it can still help reduce the amount of money you must look for from friends, family, credit cards or personal loans.
How Big Should Your Emergency Fund Be?
The new financial wisdom is to have at three to six months’ worth of expenses saved up in an emergency fund though for many this will take time to build.
The amount of money you put in each of your short- and long-term emergency funds will depend on what you can afford and what you’re comfortable with. As a guide, around $2,000 would be ideal for a short-term emergency fund, and three to six months’ worth of expenses for a long-term emergency fund.
Financial emergencies could be unexpected, such as a car or house repair. These, while potentially expensive, are limited in time and fixed in amount. The more critical event is an unexpected loss of income, either through unexpected unemployment which could be a short-term problem or a much longer, severe challenge, depending on your own circumstances and the economy.
Lastly, estimate your costs for critical expenses. These include housing, food, health, utilities, transport and debt repayments. Just because you spend $4,000 a month now doesn’t mean it would take that much to survive. You may find that your critical expenses are significantly lower than your current monthly spending, which includes such discretionary outlays as restaurants and entertainment.
Essential Emergency Fund Features
Emergency fund investments need to be guaranteed or at least very low-risk. They also must be liquid and accessible. Look for these crucial features when setting up your emergency fund:
Unfortunately, investments often realise a rate of return that is directly proportional to how much risk they carry. That is why you’ll need to be satisfied with low-interest-bearing accounts in your emergency fund.
Liquidity represents how quickly your assets can be converted to usable cash. A savings account, for example, is 100% liquid because the funds are already in cash.
Short-term emergency funds should be able to be accessed immediately. For bigger expenses, the short-term account has to hold enough over while you wait for your long-term funds to come through.
In addition to keeping cash on hand, make sure you have a debit card attached to your short-term emergency fund. That way, you can access money at any time in virtually any place.
How to Create an Emergency Fund
The emergency fund should not be treated as a personal fund for impulse buys or for large expenses that can be anticipated—such as an annual vacation. Instead, it should be a savings account used only for costly, necessary and unpredictable items such as medical bills or car and home repairs.
Once you know your critical expenses, create a plan to set aside a certain amount each month. Make this amount automatically transferred from your existing savings account or even direct from your employer. By automating the process it is more likely to happen.
You could also build your emergency fund by adding stocks that pay dividends or even use your tax refund to pay directly into the fund.
When you reach a milestone, reward yourself with a small treat, such as a night at the movies or a new book. Keep track of your goals and mark special achievements.
Tips to Build Your Fund Quickly
If you take a couple of hours to look around the house, you will be amazed at how many items you could convert to cash.
Find one-time income opportunities
There are many ways you can do some quick work and earn some money inside and outside your home. You can answer online surveys, care for pets while their owners are on vacation, participate in focus groups, and more.
Make cuts in your budget
Look at your budget and prioritise your spending, a few little cuts that you won’t notice individually will add up significantly. Cancel unnecessary subscription services or memberships.
Use Your Emergency Fund Wisely
An emergency fund can mean the difference between financial failure and financial success.
Carefully examine your expenses and use that information to develop an emergency fund goal, see how much you can save each month, and identify unnecessary expenses or wasted money. Make a plan to build up an emergency fund and decide how you want to allocate it. Finally, use your emergency money wisely by knowing what constitutes a true emergency.
To discuss ways you can develop or enhance your emergency fund, contact me today.