You are the head of the family. The company that you are working for is downsizing because of the recession. Your name is included in the list. You have no savings in place. What will you do? This is the use of the emergency fund, why it matters.
What is an Emergency Fund?
As the name itself connotes, an emergency fund is a sum of money kept aside in cases of emergencies. emergencies include a loss of job, illness, car breaking down, a major purchase. It can be anything that will cover life’s uncertainties. It is there as a kind of financial protection for the unexpected.
Why Does An Emergency Fund Matters?
An emergency fund serves as a financial buffer to keep you afloat in times of emergencies. This will prevent you from borrowing money from others. There is also no need for you to use your high-interest rates credit cards. And thus, it will prevent you from going into credit card debt.
Just take a look at what happened during the COVID-19 pandemic. Because of the lockdowns, many companies suffered and a lot of people lost their jobs. Those with emergency funds were able to go through the hard times. Unfortunately, those without emergency fund struggled with their basic needs. Thus, one lessons that we learned on the pandemic is the importance of an emergency fund.
How Much Should You Save In An Emergency Fund?
There is no fixed amount on how much money you should have in your emergency fund. It all depends on the individual. Each person has his/her own needs based on their lifestyle. But as a general rule of thumb, an emergency fund should have at least six months of your monthly expenses. The logic behind it is for example, you lost your job, you have a buffer of six months to find another job. Your monthly expenses will not be a problem, at least for the next six months.
What Counts As An Emergency?
There are many scenarios that can be counted as an emergency. At the same time, there are those things that are not counted as emergencies.
Sample emergencies include:
- Loss of employment
- Medical emergencies
- Car Repair
- Major appliance breaking down
On the other hand, the following expenses are not considered emergencies:
- Travel for leisure
- Buying the latest model of cellphone to keep up with trends
- Birthday Parties / Fiestas
- Plastic Surgeries
Emergency expenses are those expenses in which you have no choice. It involves basic necessities while discretionary expenses do not qualify as emergency expenses.
Where To Place Your Emergency Fund?
Emergency Funds should be highly liquid and easily accessible. It is not recommended to keep it at home because that is too easily accessible and too tempting not to access. In the same way, it is also not advisable to invest it in investment vehicles such as bonds, funds and stocks. More often, these kinds of investments have terms and expiration dates. You will just end up paying for pre-termination fees if you need the money before it matures.
The best place to put your emergency fund is through a bank. Open a regular savings account that is interest bearing. Please take note that this should not be mixed with your regular savings / checking account. Remember it should be readily accessible but not too accessible at the same time.
How Do I Build It?
The money jar budgeting system recommends that we allocate 10% of our monthly income to build our emergency fund. Once we have fulfilled the 6 months minimum requirement, it is recommended that the 10% allocation continues to build our savings account.
Secure your financial future. Start building your emergency fund now.
Feature Image by 3D Animation Production Company from Pixabay