“Funds set aside in the event of a personal financial dilemma, such as the loss of a job, a debilitating illness, or a major repair to your home,” according to Investopedia.
Isn’t it straightforward? It’s essentially a savings account that serves as a safety net to keep you from having to borrow money during difficult financial times. We should first select a target amount for our Emergency Fund before determining how much we should save on a monthly basis.
It is calculated based on monthly living expenses.
If you read that you need a 3-month emergency fund, for example, it indicates you should set aside enough money to cover three months of your family’s living needs.
Dave Ramsey, a well-known financial coach and mentor, has this to say about it:
- 6-month emergency fund for a family with only one source of income
- 3-month emergency savings for a family with two income sources
As you can see, households with a single source of income (like John above) require a larger emergency fund. It allows the breadwinner more time to hunt for another source of income.
The Different Types of Emergency Fund Accounts
While there are plenty of suggestions on the internet for where to keep your emergency funds, the most important rule to remember is:
Returns take a back seat to accessibility.
An emergency fund should be able to be accessed at any moment. Isn’t it pointless to have one if you can’t get it when you need it?
Still, some people, particularly those who have a very stable income and savings situation, opt for a hybrid approach and consider the rates of return when deciding where to put their emergency fund.
With this in mind, it could be a good idea to divide the various sorts of emergency funds into two groups.
Bank Accounts with a High Yield
The most popular and suggested “location” for your emergency fund is your bank account. This option allows you to withdraw emergency funds with the greatest ease and convenience.
Inquire about the various types of savings accounts offered by your bank. Most have a few interesting options that may offer a slightly higher rate of return than a standard savings account.
Money Market and Certificate of Deposits are two examples.
Alternative Investment/Emergency Fund Options: (Hybrid Investment/Emergency Fund)
As I previously stated, some people in good financial shape (high savings rate, significant accumulated assets) may prefer to use other strategies to get the most out of their emergency funds.
They are the ones who may decide to put this money into low-risk investment vehicles such as VUL or even blue-chip stocks in order to maximize their potential returns. The trade-off is that you’re putting your emergency cash at danger, so you should be very cautious while weighing the hazards.
Some people are lucky enough to have all of their bases covered (insurance, passive income, several brokerage accounts, no debt, a high profit margin, etc.) and will tell you that they “don’t need” an emergency fund.
At any given time, their current cash flow and various money sources/options are sufficient to cover 6-12 months of their living expenses. If you’re one of these people, congratulations; you certainly know how to manage your money.
What Are the Steps to Creating an Emergency Fund?
Are you ready to start building your emergency fund? Get your pen and paper ready (or bookmark this article) because we’re going to show you how to quickly set up your financial safety net.
Create a “save-up system”
Isn’t it self-evident? The majority of people fail at this step because they don’t set up a method for saving money.
The 50-30-20 Rule, for example, is a common savings strategy.
This rule indicates that 50% of your money should be spent on requirements (food, rent, bills, etc. ), 20% on financial objectives (savings, investments), and 30% on wants (entertainment, luxuries). The best part is that you can quickly modify the percentages to account for asset accumulation for your emergency fund.
You could save a set proportion (50-20-20-10 Rule) or use a portion of the 30% for leisure, at least until you reach your emergency fund objective.
Save Automatically
If possible, use your payroll’s bank’s automatic savings option, which directs a predetermined amount from your paycheck to a savings account.
This offers three advantages: first, you save time by not having to manually deposit money into your savings account. Two, it “protects” your money from wasteful expenditure (since it will no longer reach your hands come payday).
Finally, it establishes saving as a habit that is simple to maintain. Once you’ve set up the auto-save feature, you won’t have to do anything more.
What if my bank or payroll company doesn’t provide that service? Enroll your account in your bank’s online platform, if possible, so you can easily transfer funds between accounts.
Reduce your expenditures.
Cutting back on certain expenses, in my experience, is one of the most effective ways to save money.
You’ll be astonished by the results if you take an honest look at your daily spending and add up the monthly total. Take your beloved Java Chip Frappuccino, for example. At rates ranging from Php 150 to 200, this equates to a monthly outlay of (150 x 20 days) Php 3,000.
If you ask me, it’s a significant amount. Don’t get me wrong: I’m not advocating self-deprivation.
The goal is to identify areas of your spending that may be draining your budget more than you realize and make adjustments to save money for an emergency fund.
Boost your earning potential
The size of your take home pay is a key factor in determining how much you can keep for an emergency fund, whether it’s a side hustle or having some form of passive income.
Do you want to save money more quickly?
Learn a new skill, work online on weekends, or start a small business — these are all excellent methods to increase your income and assets.
Bottomline
Having an emergency fund is an important part of having a strong financial foundation. They can safeguard you and your loved ones from unforeseen economic and financial shocks, even if they are difficult to put up.
In times of crisis, emergency funds also reduce the need to borrow money, which can set one’s financial security back for a long time.
