Some of the aspects of personal finance are really exciting. For instance, investing – it’s a fascinating endeavor to put some money in the stock market, sit back and watch it grow up into a big amount over time. Or it could be buying a new house – the absolute thrill of transitioning from a renter to a homeowner is one of the most amazing experiences you can have in your life.
And then there are the other parts of personal finance which are not so exciting! For example, paying off debt is a long and painful thing, requiring a lot of discipline and patience. One of these daunting personal finance tasks is to build up an emergency fund. It seems really difficult and boring as well, to pile up the cash and stash it somewhere safe. But it’s a necessity no one can ignore.
What is Emergency Fund?
An emergency fund is an account that you keep aside to store funds for using in case of an emergency. This can be a loss of job, a major illness or an unavoidable expenditure. The main purpose of keeping an emergency fund is to stabilize your financial security and you can use it to pay for emergency expenses and also eliminate your need to go for high interest loans.
Purpose of Emergency Fund
Lots of unexpected incidents can turn up in your life and you need to be prepared to face them. The best way to face emergency situations is to have sufficient liquid money ready to use. The last thing you want is to be compelled to go depend on loans or credit cards which will practically worsen your financial situation. That’s exactly why you need an emergency fund.
The current economic turmoil has caused rounds of layoffs and getting fired from your job won’t be a very surprising incident. In case you want to switch your job and get started with a new income source, this fund will be your best friend in the mean time. Medical costs can go sky high. When you have an emergency fund, you can go on without having to choose between your health and your rent. Your car can break down, you might need to fly away to a distant state for attending a relative’s funeral, your home might need a sudden repairing and so on. It’s a necessity that cannot be overemphasized.
How to estimate how much money you need?
This is a very important question when it comes to setting up your emergency account. The general answer to this question is that you need to have the living expenses for three to six months at least. This is a very generic estimation and might seem like an awfully vague figure to anyone. After all, it could make the difference of thousands of dollars.
The more reasonable answer would be – every single person has a different situation and the emergency fund requirement will vary accordingly. These are some questions you need to ask yourself while determining how much money you should have in an emergency fund.
1. Do you own a house?
If you do, then how old are its structures and appliances? If you’re a homeowner, you should probably move towards the six month emergency fund plan. When you have a lot of assets, unexpected expenditure events are more likely to pop up. So it’s wiser to pile up a few thousand dollars and work on the six month plan.
2. How old is your car?
The older your car gets, the more repairing it will need. Although individual repairs might be cheap, they can sum up to a big amount over time. If your car is very old, it’s more appropriate to save six months of living expenses in your emergency fund.
3. Do you have a stable job?
This is probably the most influential factor which can determine the size of your emergency fund. If you are self-employed, a seasonal contact worker or a freelancer, then you should definitely have six months of living expenses over the safe zone. However, if you have a stable job or working in a high-demand industry with a high probability of securing a new job quickly in case of a sudden layoff, then you’re good to go with three months expense.
4. Are you well-insured?
Check if your health insurance is good enough. The top reason for bankruptcy of people in the modern world is because of a major medical crisis outside the coverage of health insurance. If you’re facing a medical emergency, it’s safer to save six months expense.
Sometimes, insuring yourself is merely not enough. As those family members who are depending on you as a breadwinner are also exposed to health risk. If your whole family is adequately insured, then it’s okay to have a lower emergency fund buffer.
5. How big is your family?
The bigger your family is, the bigger are the chances for unexpected expenses. However, if you’re a single person with a steady job, three months living expense in the bank is good enough for you.
These questions are not all that you should consider while determining your emergency fund. As stated before, the cases are different for different people. Evaluate your life, predict your future needs and choose an amount that would make you feel comfortable. It’s good to remember that this emergency fund will be your biggest help when you fall. So make sure you’ve got a big net to hold on!
Different ways to calculate emergency fund size
The size of your emergency fund depends on a lot of factors. Based on these factors, there are different ways to calculate your emergency fund size. The most common and popular way is to calculate based on monthly expenditure. Everyone has an estimate of how much money is required to comfortably cover a month’s expenditure. You can have your emergency fund store your living expenses for three, six, nine or twelve months.
What should you do with the Emergency Fund?
The emergency fund account should be separate from the regular bank account. That way, you’ll be able to keep away the urge to use it at normal times. The ATM machines or online transfers have been a blessing to mankind, allowing you to access the money whenever you need it.
If you’re looking for the best place to invest your emergency fund, a fixed-income fund can be an excellent option. These funds invest in very short terms and are highly conservative. The net asset values of these funds do not vary much. Due to the fact that these funds invest in bonds issued by government and large scale companies, they are perfect for investors who prefer not to put their principal at risk.
Getting started with an Emergency Fund
You should set up a small initial goal. It’s not wise to bite off more than you can chew. The bigger your goal is, the more difficult it will be to reach there and you’ll feel like giving up. Set a reasonable target. Let’s say, you plan for an initial goal of setting up an emergency fund of RM1500. This is a goal that can be reached in about a few months (or even less if you have a better income state). Despite being a small amount, this can make a huge difference when it comes to an emergency situation.
Now break this amount into smaller pieces. If you can save RM125 in a week, it will add up to RM1500 in just three months! So it’s highly recommended not to set a very high savings plan. The number should be challenging but not unreachable.
You’re probably thinking that it would be very difficult to save RM125 per week, considering that you barely make ends meet now! Well, this is a very common sentiment coming from people all around us in the initial stage of saving for an emergency fund. This problem can be overcome with a few tricks. Look out for all the ways you can save some extra money and you’ll be on your way to a safe future soon enough!