We have all experienced unforeseen financial shocks- a fender bender, a broken appliance, an unexpected medical bill, loss of income, or even a damaged mobile phone. Large or small, these unplanned expenses often feel like they pop up at the worst times.
Setting up a cash reserve is an essential way to protect yourself. By setting aside either small or large cash reserves for these unforeseen expenditures, you can retrieve quickly and get back on track towards accomplishing your long term goals.
What Is An Emergency Fund?
An emergency fund is a cash reserve expressly set aside for large unforeseen expenses or financial emergencies. These unexpected expenditures do not include recurring monthly expenses.
Given the current economic fallout due to Covid 19, it is more important than ever to have an emergency fund to face financial distress. After uncertain situations like medical emergencies or loss of income, your emergency fund can be a lifeline.
Nothing helps you sleep better at night than a strong back up of funds to face the calamities.
It is perhaps the most important financial decision of any well-rounded financial plan that ensures your basic lifestyle is not affected. And you can survive in the uncertain conditions without having to resort to additional debt, either through high-interest loans, credit cards, or mortgaged assets.
Why You Need Emergency Funds?
Emergency funds are significant to have in place as a buffer for your finances.
Without savings, a financial shock- even minor- could set you off guard. And if it turns into debt, it might potentially have a long-lasting impact. Experts recommend having emergency funds for at least three to six months of routine expenses in reserve.
Because they safeguard you in the event of unexpected financial blow and have numerous benefits, out of which few are shortlisted below:
1. Peace Of Mind
The significance of emergency funds can't be denied as it gives you peace of mind. A backup of a cash reserve becomes your spine in an unexpected crisis. It reassures that you can float through a financial crisis without lifestyle changes and sacrifices
. This assurance enables you to focus on your current work and improves other life areas by minimizing financial stress.
2. Money Saved
Apart from preparing for an unforeseen crisis, one of the significant benefits is that it helps you protect your retirement savings. It allows you to achieve long-term financial goals, like owning a house, buying an expensive car, etc. Additionally, it prevents you from borrowing for your future self.
3. Helps In Budgeting
When you start budgeting, you might inadvertently leave out some necessary expenses. In such situations, emergency funds come to the rescue and make up for the first year's costs. Then you can add these expenses and adjust your budget
in the following year.
It could be annual expenses like fees for organizations, taxes, or due gifts.
4. Serves As A Backup
If you have only one source of income, it is pivotal to have a substantial emergency fund. It can serve as a backup if an unexpected job loss or emergency medical conditions keep the primary breadwinner from working.
5. Essentials For Self-Employed Or A Contractor
Emergency funds are mandatory for those who are self-employed and cannot claim unemployment benefits. Plan additional savings when your business is expected to be slow or when your contract is about to end.
6. To Combat Medical Emergencies
Putting off those extra savings may sound easy in good times, but the true worth of emergency funds crystallizes when you need it. Extreme medical conditions can cause you to exceed your deductible every year.medical issues may turn out very pricey, and insurance companies don't pay for everything.
Well-funded emergency savings can work as a safety net to afloat you through such a medical crisis.
7. Avoid Costly Debts
Emergencies may pop up anytime, and if you don't have an emergency cash reserve, you may drown in costly debts. Relying on borrowed money through credit cards or bank loans may result in higher interest rates that will cost you a fortune in the long run.
How Much Should Be Saved In Emergency Fund?
The rule of thumb is to have enough savings in your emergency funds to cover three to six months of worth expenses.
Here are a few different emergency fund calculators that help you find out how much should be saved every month while creating an emergency fund:
Your emergency fund size depends on your circumstances. For example, freelancers with variable income might want to save more because they might not know when the next paycheck is coming.
How To Build An Emergency Fund
Creating an emergency savings fund is pivotal because it works as a buffer for your finances in financial shock. There are countless tips to create an emergency saving fund to get your savings started, but in the end, it all comes down to money. You either need to save more, make more, or both.
Building any savings size is a lot easier if you have the habit of consistently putting money away. It is the fastest way to see it grow. If you are into the practice of savings, here are some excellent and practical ways to create and stick to the habit of saving:
1. Estimate The Total Amount You Need To Save
The first and foremost step in building an emergency saving fund is to figure out the total amount you will need to save for the recommended three to six months' worth of expenses. It can be easily estimated using an emergency fund calculator.
2. Save The Change
Put the change or any amount you get breaking the bills in a jar at home. Once the jar is full, relocate the amount to your savings account. Some have also successfully saved a lump sum implementing saving-money challenges.
Like the $5 bill hack, with which you can save a handful of money by putting away $5 on every bill over the year. And if you tend to use coupons much, try to put the amount you save directly into your emergency funds.
3. Set Monthly Saving Goals
Setting a goal for your savings helps you stay motivated. Once you estimate the amount you want to save, stagger your plan into smaller monthly deposits. It infuses the traits of savings in your lifestyle and makes the daunting task of savings much more manageable.
Another way is to automatically deposit a portion of your paycheck into your savings account each time you get paid.
4. Reallocate Lump Sum Receivables
It involves any influx of money you may receive over the year, like lottery winnings, bonuses at work, or an envelope from your aunt on your birthday. Keep aside a small portion to celebrate and allocate the rest to your emergency fund. It is the most effective emergency fund strategy and it helps you fast-track goals.
5. Cut Down The Expenses
Reigning in on the avoidable expenses will allow you to achieve your saving goals
quicker. Though you don't have to turn into a complete cold turkey, prioritize your expenses. Instead of dining out every weekend, limit it to alternate once or twice a month, plan your movie time at home, restrict non-discretionary online shopping spree, etc.
6. Monitor Your Progress
Finding a way to watch your progress offers gratification and encouragement to keep going. Never forget to check in on your savings every couple of months to ensure you are on the right track to reach your targets. Make any adjustments needed after any significant purchases or life event for which you had to dig into your savings.
7. Use The Money-Saving App
These apps devised to automate the saving process in a barely noticeable way. Many of them save through 'round-ups,' where the total bill is rounded up to the nearest whole dollar, and the extra change is automatically transferred to your savings.
1. Best investment options: Acorns
3. Best banking alternative: Simple
8. Put Your Tax Refund Into Saving
You get a shot at this once a year- so don't blow it! If you get a tax refund, saving it can give a quick boost to your savings stash. While filing your taxes, consider having your refund deposited directly to your savings account.
9. Pay Yourself
Suppose you save some bucks by eliminating non-essential services from your budgets, like cable television, a housekeeper, lawn care, or a hairstylist. Invest the amount you are saving directly into your emergency funds account.
10. Only For Financial Emergencies
What is not easy, is committing your savings funds for emergencies only. It's going to be very tempting to spend this large amount for on other things, such as:
⦁ Buying gifts
⦁ Going for vacations
⦁ Buying new things
⦁ Dining out
Thus, emergency funds are your lifeline to be used in case of emergencies only.
Where To Keep Emergency Fund?
The most common question that arises in our minds is where to secure these funds.
The key to storing emergency funds is to make sure the money is easily accessible but not too easy to access.
For example, it is not advisable to keep your savings funds at a place where they can easily mix with your regular savings, or you might accidentally spend it. There are a variety of options to choose from, like: you can choose the one that makes the most sense for you.
One option is to keep your savings in the form of cash. It is the most accessible yet the most tempting one to spend on non-emergencies. Besides, money is always on the verge of being stolen, burned in a fire outbreak, or any other natural disaster, or lost somewhere in the house.
2. Bank Account
It is the most secure and safe option to save your money in the bank account. Bank accounts are of several types with different characteristics, and they all tend to keep your money safe:
⦁ High-yield bank account
⦁ Traditional bank account
⦁ Money market account
3. Prepaid Card
A prepaid card is a card that you can load money onto. It is not related to any bank or credit union, and you can only access the amount you have loaded on the card.
4. Certificates Of Deposit
Another option to keep aside an emergency fund is in certificates of deposit (CDs). However, money is not easily accessible when it is secured in CDs. CDs earn a relatively higher interest rate than other bank accounts if you keep your money in the account for a specific period of time.
When Should I Use Emergency Fund?
It is best to save your emergency funds for emergencies. Set some guidelines for yourself as to what constitutes emergencies or unexpected expenses. Sometimes an out of the box expense is not an emergency but still falls outside your monthly budget. You can use your savings funds to pay it off but avoid making it a habit.
Definitely, don't pay any of your savings on things that are wants, not needs. However, don't be afraid to use it at times of dire need.
If you spend down everything you had in the saving bucket, just build it up again. Practicing your saving skills will make this task a lot easier with time.
Go Forth And Save
Now that you are fully armed with the resources, you immediately need to start emergency funding. It will make your future much brighter and secure.
Take time to calculate your expenses and personalize your savings goals. Then figure out how much can be saved each month to build an emergency fund. Establish your fundraising strategies according to the budget and financial situation.
Remember, your emergency fund is something you will have to continually work on. If you spend your funds in an emergency, you will have to work on rebuilding it again as soon as possible.
Go on with this ultimate emergency fund guide to learn more about determining a savings goal, where to stash your savings, and alternatives to consider in a financial crisis.