A guide to building an emergency fund
- From unexpected home repairs to medical emergencies and a sudden job loss, life is unpredictable. Having an emergency fund, in other words, a stash of money set aside to cover these financial surprises can eliminate much of the costs and stress these events typically bring about.
- Apart from preparing you to face unexpected expenses, an emergency fund can also prevent you from spending money on a whim or opting for quick access to cash that could involve high interest rates, fees and other penalties.
- An emergency fund should cover between three and six months’ worth of expenses, but ultimately how much you decide to save each month will largely depend on the budget you have set and your monthly expenses.
- To build an emergency fund you must first set a budget, while you need to ensure that you save as soon as you receive your paycheck.
- If setting a monthly savings goal is proving to be harder than expected, you might want to consider reducing your expenses. Also, you may want to consider increasing your monthly income so you can save more towards your emergency fund.
- Ideally you should try to strike a balance between earning interest and having easy access to your money. Investment vehicles that offer both interest and liquidity include mutual funds, money market funds, as well as high-yield savings accounts.
- A necessity you should not live without, an emergency fund can offer that much-needed long-term security. Explore CC’s full range of saving plans that can help you stretch your monthly income so that you can add more capital to your emergency fund or visit one of our local branches.
At times, life can be very unpredictable – a storm causes extensive damage to your home, a scenic drive into the countryside leads to two flat tyres, a skiing trip is cut short as you end up in crutches, while a meeting with your HR manager sees you being laid off. Unexpected emergencies such as these are a fact of life, however, living with the security of an emergency fund is priceless since it can help you be better prepared for these unplanned emergencies without having to take on more debt, while it can also help safeguard your other long-term investments.
The backbone of any comprehensive financial plan, if you are aware of the merits of having an emergency fund but are not quite sure how to make it happen, here is a guide about boosting that all important savings buffer.
What is an emergency fund and why you need one?
An emergency fund is a readily available source of money that could help you navigate any financial dilemmas that you may find yourself in. As a result, it can serve as a financial safety net, preventing you from being caught off guard and from having to take out money from high-interest debt options like your credit card or undermine your future security if you end up having to tap into your retirement funds.
A sudden job loss, a medical intervention, car trouble and even major national crises that could lead to financial crises such as the COVID-19 pandemic are all events an emergency fund can help you weather.
However, it is important to bear in mind what is not an emergency. Here are some examples:
- Large, planned purchases like buying a house or a new car.
- Large, planned future payments such as your child’s university fees.
- Random, on the whim purchases like a designer cocktail dress.
- Non-emergency house repairs such as replacing your worn-out tiles with wood flooring.
- Elective healthcare such as plastic surgery.
What other benefits are there to having an emergency fund?
Apart from offering financial stability and preventing you from having to live on the financial edge, there are other pros to having an emergency reserve of cash. Keeping money earmarked for your emergencies out of your immediate reach makes it much more difficult to use on things like a new TV or clothing. At the same time, it can stir you away from making bad financial decisions like using other alternative ways to access cash quickly which could involve interest, fees and other penalties.
How much money should your emergency fund have?
This will vary from individual to individual based on their income and lifestyle. At the same time, you must also consider how your emergency fund fits with the rest of your financial priorities. No financial plan yet? Read along why having one is important and how you should go about drafting yours.
Broadly speaking, financial planners recommend that you cover between three and six months’ worth of expenses, while you also need to ensure that these funds are highly liquid and you can access them as soon as the need arises. For instance, for a couple with expenses totaling around €5000 a month, including things like home loan payments, groceries, car payments and other necessary monthly expenses, they will need to set aside at least €15,000 for three months and as much as €30,000 for six months.
If you are just getting started with setting up your emergency fund or you are knee-deep in debt, it might be best to save a starter emergency fund of around €1000 and then once you are out of debt, beef up your monthly savings so that you can build an emergency fund that covers three months’ worth of expenses.
How to build an emergency fund
Starting early is key to building a comfortable cushion against unexpected mishaps that could crop up at one point or another in your life. And getting started is easier than you may have thought. Here are a few simple steps you can follow:
1. Make a budget and live by it
To do so you must list all your monthly income and expenses. In this manner, you will have a clear picture of how much money you have available. But part of setting up a budget is also determining your monthly expenses. These will vary from person to person and whether you want your emergency fund to cover small luxuries or you would rather have a more bare-bones kind of a fund with just enough money for you to pay the bills.
2. Set a monthly savings goal
Setting money aside for your emergency fund should be your first priority as soon as you receive your paycheck. In this manner, you will not be tempted to spend it on other, less important things. As time goes by, you might have to adjust how much money you save. For instance, you may be able to save more if you got a promotion at work.
Think you do not have what it takes to save and you are concerned that you will succumb to your spending weaknesses? Then try automating your savings by perhaps setting up an automatic transfer as soon as you get paid.
3. Slash your budget
If the above step is proving to be harder than expected, you might want to consider reducing your expenses. For instance, consider cutting down on eating out each month, switching to a cheaper cable provider or downgrading your cell phone plan even if temporarily. Once you give it some thought, you may realise that you can do without certain things. Then, once your emergency fund reaches a healthy balance, you can start increasing your spending.
4. Make more money
Lastly, you should consider increasing your monthly income so you can grow your emergency fund. Opt to work some overtime, pick up a part-time job or start a small business in your free time. An easy way of making some money with little effort from your end is to sell things you do not need or use any longer. Here are some ways to make money while you sleep.
Alternatively, if you happen to get your hands on a windfall be it a tax refund, a bonus from work or money as a gift, make sure you save it.
Where to put your emergency fund
When considering where to save your emergency fund, you first thought is probably a classic savings account in a typical brick-and-mortar bank. While the benefit of doing so is that you can gain easy and almost instant access to your money which is particularly important in times of need, the problem with this option is that you will earn little or no interest in today’s low-interest-rate environment and when you are not earning interest, you are losing money to inflation every single year.
Your emergency fund should ideally strike a balance between earning interest and allowing easy access to money. For this reason, you might want to consider what are known as liquid assets. A liquid asset is either available cash or an instrument that has the capacity to be easily converted to cash.
Here are some options:
- Mutual funds – these consist of a managed portfolio of investments wherein money from various investors is pooled and invested in a variety of different financial securities, including stocks and bonds.
- High-yield savings accounts – interest rates on these accounts can be as much as 20 to 25 times higher than what traditional savings accounts offer. Yet, before settling with a provider, weigh in factors like initial deposit requirements, interest rates, any fees and minimum balance requirements.
- Stocks and bonds – you also have the option to invest your emergency fund in stocks and bonds, however, it is important to note that although you may earn a higher return, your money would be less liquid and subject to considerable risk. In addition, you can never be certain if the markets will be up or down when you need to sell, while it can take several days to settle a sell and have your money transferred to your account.
Whatever your choice, make sure you can access your money quickly, easily and without any withdrawal penalties. With this in mind, put some of your emergency funds in less-liquid and higher risk options such as bonds and stocks only if you have a large emergency fund and you feel you might not need to access all the money at once.
When is it ok to dip into your emergency fund?
If you think you are facing some sort of a crisis that may need funds to see you through it, take a step back and ask the following questions to ensure that this is indeed a genuine emergency.
- Is it unexpected?: Think of things like job loss, pay cut or fewer working hours that could negatively impact your monthly income. Car accident repairs or flood damage to your house are unexpected incidents. Your yearly car insurance, getting Christmas presents for all your family or back-to-school shopping are not. These are things you should budget for.
- Is it urgent?: You must also decide whether this mishap can wait or it is something urgent. A broken-down AC in the height of summer is a necessity and therefore probably something urgent. A good deal at your favorite gadget store at a bad time for your budget can wait and should not be regarded as an emergency.
- Is it needed?: Here you need to distinguish between needs and wants. Losing a reliable mode of transportation like your car is a need, but upgrading to a newer and nicer car is a want.
A necessity you cannot live without, an emergency fund can offer that much-needed long-term security and can help you weather a crisis without falling into debt. At the same time, it has the power to turn major emergencies into mere inconveniences.
Explore CC’s full range of investment options that can help you stretch your monthly income so that you can add more capital to your emergency fund or visit one of our local branches for a free financial health check which includes a review of your current financial situation and a customised financial plan tailored to your needs.
The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.
Calamatta Cuschieri Investment Services Ltd is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.