Life in general is full of surprises. We don’t know what tomorrow brings and this includes unexpected events like emergency situations.
People are fond of saying “we will cross the bridge when we get there” when they think of the future. Most of us tend to live each day in the present and not worry about what could happen ahead. However, there is a danger in this kind of thinking.
What if (knock on wood) you will encounter an accident tomorrow? What if tomorrow is your last day at work because your company is doing a massive retrenchment of its employees? How prepared are we for these kinds of circumstances? Are we financially capable of supporting ourselves when these things happen?
This is where the emergency fund comes in. If you don’t have one yet, it’s time to start building one. Right now.
What is an emergency fund and when do we need it?
Investopedia defines emergency fund as an account for setting aside funds to be used in an emergency. It can be a temporary income supplement in case of sudden job loss like retrenchment. It can also be used to pay for medical expenses when critical illnesses strike in the family. It’s also a big help in times of economic crisis, which can affect businesses and consumers alike.
There are some scenarios that may not be considered big problems but they still require immediate solution like when your car breaks down suddenly, or your refrigerator needs an overhaul or your washing machine needs to be repaired. The purpose of an emergency fund is so much more important than saving for our wants.
How much should we allocate in emergency fund?
The rule of thumb for most financial planners is that an emergency fund should be equivalent to at least six (6) to eight (8) months of one’s monthly income. Let’s say you are earning USD $1,000 a month so your emergency fund must have at least USD $6,000 to USD $8,000 in it.
The figure might sound overwhelming at first but there are a lot of ways that can help us achieve and build our first emergency fund.
Important note: banks do not have an account labelled as Emergency Fund – it is up to you to set up this cushion account with the purpose “for emergency needs.”
Why do we need an emergency fund?
- 1. Having an emergency fund will prevent us from accumulating very high interest debts like personal or credit card loans or other types of multi-purpose cash advances.
2. If the unexpected does happen and we have an emergency fund, we won’t be forced to sell our investments at a loss or dispose of assets like jewelry through a fire sale.
3. With an emergency fund, we just tap that cash to solve whatever–unexpected–financial problems we encounter. Less worry, less stress.
In a recent survey conducted by Bankrate.com, 37% of Americans have enough savings to pay for a $500 or $1000 emergency. The remaining 63% resorts to cutting down of expenses (23%), getting credit loans (15%) and borrowing money from friends and relatives (15%) just to meet the unforeseen emergencies.
We have to understand that building an emergency fund does not mean we have to set aside the full amount right away or on a one-time basis. When done early, gradually building the fund becomes easier and affordable as we can do it frequently and in small amounts. It’s just like what the quote says: little strokes fell great oaks.
Now that we understand what an emergency fund is and why we need it, we go to the next question: How?
How to set up an emergency fund?
As mentioned earlier, there are numerous ways to start building your first emergency fund. One option is to open an ordinary savings or checking account from the bank. This account must be separate from the other accounts like: the account connected to your payroll at work for the daily expenses, time deposit for mid-term savings, and mutual funds for long-term or retirement plans.
Majority of the banks offer automatic debit arrangement (ADA) wherein emergency funds are linked to a payroll account. ADA is scheduled depending on the dates you chose. Avoid putting it in an account with a lock-in period as some accounts have maturity dates of withdrawal and pre-termination charges apply.
Having an emergency fund doesn’t mean it will lessen inevitable things from happening. It will however, serve as your backup plan and make you more equipped to face whatever ordeals that life throws at you, unexpected or not.
As actress Mila Kunis once said, “Always have a backup plan.”