A Guide to Emergency Fund: What It Is and Why Does It Matter

With proper cash management and financial planning, you can have savings to weather the unexpected. See how to build your emergency fund here.

May 23, 2024 - 13:03
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A Guide to Emergency Fund: What It Is and Why Does It Matter

For most people, life is about simply getting through it. But what are you going to do when one day, you get a flat tire, your refrigerator suddenly stops working, or you or a family member gets sick? 

Even if you're working and earning a steady income, the unexpected could disrupt your finances. Sometimes, these incidents deal a hefty blow to your bank account and leave you scrambling to recover.

Preparing for the unexpected isn't a luxury but a necessity. Not only must you practice sound financial planning, but you also need to prepare for unforeseen circumstances. Enter an emergency fund. If you find yourself in some financial difficulty, it can be your savior.

But what is an emergency fund, and why does it matter? Read on to learn more.

Importance of an Emergency Fund

An emergency fund is the amount of money you specifically set aside for any unexpected events that life may throw your way. It acts as a buffer to soften the impact on your budget and how you allocate your expenses.

This fund is an effective cash management technique that can help provide you with some money in the event of a medical emergency or job layoff—giving you a sense of security and peace of mind while you recover. It ensures that you have accessible cash to cover unexpected expenses and prevents the need to rely on credit cards or loans.

How much should you save?

The truth is, there's no one-size-fits-all answer on how much you should save money. The ideal amount comes down to your circumstances, though there are some general guidelines you can follow.

For instance, the typical recommendation by experts is to set aside 3-6 months' worth of expenses. The range considers the average duration you might be out of a job if that happens and the amount of time it takes to recover from other setbacks. 

The 3-6 month guideline guarantees that you're prepared enough without tying up too much cash that you could invest or use for other goals. Three months can cover temporary hindrances, while six allows for extended financial security.

However, keep your lifestyle and circumstances in mind. Check your risk factors when investing and how much your income can sustain. By personalizing your emergency fund, you can plan a more realistic budget for yourself and the goals you must hit.

Building Your Emergency Fund: Strategies and Tips

Building and maintaining your emergency fund requires consistent effort and strategic planning. Here are some strategies you can apply:

Automated transfers

One of the most effective ways to build your emergency fund is by setting up automatic transfers of your savings to another account. Doing so makes setting aside money a part of your routine, keeping it consistent and hassle-free.

Automatic transfers also mean it's out of sight and out of mind, so you avoid the temptation of using that money for something else other than emergencies. 

Budget review and adjustments

Over time, your lifestyle and spending habits may change. Try to review your monthly expenses from time to time and identify areas where you can cut back. Redirect any surplus towards your emergency fund. 

These minor adjustments can significantly impact your savings as time passes, helping you reach your savings goal faster. 

Monetizing unused items

Turn clutter into cash by selling items you no longer need. Set up a garage sale or sell unused items online to generate additional funds for your emergency savings. Not only does this declutter your space, you also get a little compensation for it.

Some items you can consider selling are old clothes that are still in good condition, toys, shoes, jewelry, and other small trinkets. If you recently upgraded some electronics and appliances, you can sell the old ones, provided they still work.

Exploring side hustles

The gig economy accelerated during the COVID-19 pandemic, with many people supplementing their income by freelancing. You can consider working odd jobs to earn a little extra for your emergency fund. 

Some of the popular side hustles are working as delivery drivers, online tutors, and virtual assistants.

Utilizing windfalls

Windfalls, such as tax refunds or salary bonuses, can be a surprising but welcome addition to your emergency fund. Allocate these unexpected income sources towards your savings to expedite its growth without impacting your regular budget.

Additional Tips for Success

Setting up a separate bank account is the easiest way to build up your emergency fund. However, when choosing the type of savings account, you must consider factors like accessibility and potential interest rates—which could differ from bank to bank.

Opt for an account that allows easy access to your funds and boasts competitive interest rates. Not only will your money be readily available in times of need, but it can grow over time as you invest more.

Also, make sure to monitor your funds consistently as they inch toward your goal. Make use of financial apps or spreadsheets to track how much it grows over time. Every time you hit a milestone, celebrate with a small treat to keep yourself motivated and reinforce the habit.

Finally, life is constantly changing, so be ready to adapt when your circumstances change. Review your savings and adjust your spending to align everything to your emergency fund's growth. 

It Always Pays to Be Prepared

When the unexpected happens, your emergency fund can be your anchor—preventing you from spiraling into financial ruin. While it may prove to be challenging to do, especially since you're already building your savings, an emergency fund is something that you're—hopefully not—going to need in the future.

No matter how well you prepare, life will always be throwing curveballs at you, and the best way to overcome them is by preparing for them. While the basic guideline is to save 3-6 months' worth of living expenses, you can tailor your savings to your lifestyle and circumstances. Adjust your spending, keep your goals realistic, and celebrate when you hit a milestone. 

Keep your savings consistent, so when life throws something at you, you can weather it with no worries due to your preparation.

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