Category: Emergency Fund

Emergency fund- Ways to build and how much is needed

Emergency fund- Ways to build and how much is needed

In addition to maintaining a savings account, it is essential to have funds set aside for financial emergencies – those unexpected, unplanned events that can catch you off guard. Financial emergencies can vary greatly in nature but all have one thing in common: they require you to be prepared financially, so they don't cause a significant financial setback. These emergencies can include medical crises, job loss or extended leaves, the loss of a family member or close friend, unexpected home expenses, and more.

An emergency fund is essentially a sum of money reserved to cover such unforeseen life events. This reserve allows you to sustain yourself for several months in case of an unexpected expense. The key is that it should be readily accessible when the need arises. The true importance of an emergency fund lies in its ability to provide a safety net during these critical times.

Determining how much to set aside for an emergency fund depends on individual circumstances. Ideally, an emergency fund should cover at least six months' worth of living expenses, which can include utility bills, loan payments (such as home and car loans), insurance, groceries, school fees, healthcare costs, and other essential expenditures. It's also wise to factor in occasional or annual expenses like car maintenance and quarterly auto insurance payments. If both partners in a family are employed, a six-month reserve is usually sufficient, but if only one family member is earning, it's safer to aim for nine to twelve months' worth of expenses.

To build an emergency fund effectively, follow these tips:

  • Set a clear target: Determine how much you need in your emergency fund and decide on a monthly contribution to reach your goal. Calculate how long it will take to achieve the target based on your regular contributions.

  • Trim excess spending: Reducing unnecessary expenses, such as dining out excessively or excessive entertainment spending, can free up money to contribute to your emergency fund.

  • Automate your savings: Set up automatic transfers from your main account to your emergency fund account, using electronic funds transfer facilities.

  • Celebrate milestones: Track your progress and reward yourself when you reach specific savings goals to stay motivated.

Using credit cards or lines of credit as a fallback option should be a last resort. Paying for emergencies with credit cards can end up costing significantly more due to high-interest rates. It's crucial to pay off credit card debt promptly to avoid compounding interest charges. Credit cards are only a viable option if you have sufficient savings in a readily accessible account and can pay off the card balance in full each month to benefit from rewards or cashback.

The necessity of having an emergency fund cannot be overstated. It's a vital component of financial security. While some individuals with substantial assets might not need to save as much, it's still prudent to have a financial cushion for unexpected events.

To prevent yourself from dipping into your emergency fund for non-emergencies, consider the following:

  • Clearly define the purpose of the fund by opening a separate account dedicated to your emergency fund, which you commit not to touch for other purposes.

  • Make your emergency fund less accessible by moving it to a different bank or account with limited access.

  • Set aside some spendable savings in case you need quick access to cash for regular expenses.

Inculcating good financial habits, such as consistent saving and building an emergency fund, is crucial. Developing the discipline to accumulate enough money for your emergency fund can help you weather unexpected setbacks and reduce the need to borrow money at high interest rates. Create a systematic plan to build your emergency fund over time and make sure to replenish any withdrawals within one month from your contingency savings.

Author: Debalina Roy Chowdhury, Dilzer Consultants