Emergency fund: Why and How to build one?
Growing up, we’re often told to save for a rainy day. As kids, many of us didn’t heed this advice, choosing instead, to spend our money on the next best toy or video game. However, it is only when we grow older that we realize the importance of the values our parents instilled in us.
Learning how to save money from a young age is known to have numerous benefits. For one, it teaches you the value of money and motivates you to work towards your goal of buying a new book or a video game you really want. While kids put their money into a piggy bank for a rainy day, adults use the same principle to save their money in a bank account known as an Emergency Fund.
What is an Emergency Fund?
As the name suggests, an emergency fund is money that you put aside for emergencies. It is the money that you can reach out to during your hour of need and pay for those unforeseen and unexpected expenses such loss of a primary job (the main source of income), medical emergency, personal emergencies or even a car breakdown. You need to have a solid financial plan for the future and an emergency fund is an essential tool in helping you do just that.
Many people often find it hard to grasp the concept of saving for an unexpected circumstance as it is much easier to live in the movement and spend money on the things you love- money buys happiness, right? But an emergency fund can help you in darkest hour and statistics provide the proof. According to a report by the Federal Reserve on Economic Wellbeing in the U.S. Households in 2015 showed that when faced with an emergency of $400, 47% of Americans had a hard time coming up with the money without using their credit card or borrowing from family and friends. This shocking statistic is reason enough to start working on that emergency fund immediately.
The financial experts recommend that before you start making investments for your long-term goals, first you should build an emergency fund which should be greater than at least three times your monthly expenses. In other words, even if you lose your primary source of income, you should be able to survive at least three months through your emergency fund. For example, if your monthly expense is equal to $2,500, then you should have at least $7,500 in your emergency fund. It would be even better if you can build an emergency fund to cover six months of your expenses as it will reduce the need to draw from high-interest debt options, such as credit cards.
Moreover, this fund should be highly liquid i.e. readily accessible in case of emergency situation. A few good options to build your emergency fund is via savings account or money market funds. Additionally, avoid investing your emergency fund in instruments with lock-in periods or those which are subjected to penalties in case of early withdrawal.
How to build an emergency fund?
By now you understand why an emergency fund is so important and want to create one for yourself. Building an emergency fund is incredibly easy and only requires some discipline and resilience on your part.
So how do we do this? Like with all other things in life we need to start small. Here are a few ways to help you get started:
1. Big things have small beginnings
Saving is key to having a financially secure future and have an emergency fund is an important part of this. Saving a large amount of money for an expense that may or may not happen in the future is a hard thing to do. So take baby steps with your fund and start with saving small amounts of money. This could even be as low as $30-$50 dollars a month as long as you are actively putting away money for the future. Although you start out small, you need to have a goal as to how much money you would ultimately want to have in your emergency fund. Setting a fixed goal makes it easier to work towards it.
2. You don’t need all that coffee
Many people live paycheck to paycheck and often find it hard to put away money for the future. If you find yourself in such a situation, you need to look at your existing expenses and try to cut back on what is unnecessary. You can start by accounting for your expenses every day and putting them into different buckets. This can help you identify areas that you spend too much money on like all that expensive coffee or those frequent restaurant meals. If you are really trying to build that rainy day fun, try cooking all your meals at home for at least 5 days a week.
3. Automate it!
To successfully build an emergency fund you need to control your expenses and put away a certain amount of your paycheck every month. While this is easier said than done, one way to make the process simpler is by having an automatic transfer of a fixed amount from your bank account every month. This serves two purposes, one, the amount in your bank account will be lower meaning that your expenses will be in control and two, you won’t even have to think twice about putting away money since the process is now automated!
4. Get creative with saving
As you begin to get more serious about building your emergency fund, you can find new and creative ways to save money. When you begin to assess your income and spending, you may find some unnecessary leaks in your income. This could be canceling subscriptions that you no longer use for magazines or apps. These payments are automatically charged to your debit or credit card and can add up quickly. Additionally, with over the top (OTT) platforms like Netflix and Amazon Prime, the trend has shifted to online entertainment, making cable TV obsolete. So take a good look at your cable channel list and try to cut channels that you no longer watch or need. While these costs may not seem as much, they can amount to a lot of savings over time.
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Alternatively, look for ways to increase your income stream. You can get a freelance job or have a side hustle like babysitting or dog-walking.
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5. Celebrate your accomplishments
While the goal of an emergency fund is to save money for a rainy day, it is also important to reward yourself once in a while. This doesn’t have to be a big splurge, it could even be a meal at your favorite restaurant or a new book. Rewarding yourself will motivate you to keep going and achieve all your saving goals!
An emergency fund can help you when you have a financial setback and is an essential tool for financial success. In addition to saving money, you will have the added advantage of earning a high-interest rate on the money. Once you’ve built up a system of saving money every month, you are well on your way to building that emergency fund but most importantly make sure to use your money wisely!
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