This is Stage 6: Start an emergency fund. Before reading this article, please take the time to read:
An emergency fund is money set aside for the rainy days. It prepares you to be ready for life’s unexpected events, which can be inconvenient and costly.
Some of the common emergency situations that are a fact of life are:
- medical care
- natural disasters like flood, fire, and storm
- economic downturn
- unplanned expenses
Why you need an emergency money
An emergency fund allows you to manage life’s risks. It prevents you from making financial decisions that might not be to your advantage, like dipping into your retirement fund or selling a property at a bargain price.
Benefits of an emergency fund
The benefits of having a well-stocked account for the rainy days are to:
- have available cash during emergency
- protect your financial plan that you set in place, ensuring that your goals are still on track
- avoid making sudden but bad financial decisions
- lessen your worries
- make you independent and not too reliant on aid
Difference between insurance and emergency fund
Insurance and emergency fund are crucial to sound financial planning.
They form part of personal risk management because they soften the impact of emergency situations.
An insurance policy, however, does not cover all situations, and there is a chance that a claim can be denied. It might also take some time before you are going to get paid by the insurance company.
This is where emergency fund plays its role; it is a cash ready to be used at any moment’s notice and when a pressing need occurs.
Where to save your emergency fund
It should be in cash form deposited in an account that you can get access to at any time. Try your hardest to let it stay where it is, and not spend it on impulsive purchases. Remember to withdraw funds only when your circumstances call for it.
How much money should you have in your emergency fund
You can start with a minimum of 3-6 months’ worth of your income.
In reality, the size of your emergency fund depends on many things. For example, a breadwinner of a family with three children should have savings larger than that of a single professional with no dependents.
There is a maximum too.
Too large a rainy day fund might deprive you of the opportunity of earning more from your money. Bear in mind that because emergency fund is in cash so you can get it easily, you will have less chances of making it grow compared to when it is invested.
Next step: Start small right away
It is important that you start saving for an emergency fund as soon as you can. You can start small and then build it over time. Once you have what you think is enough, then you can begin letting your money work for you through investing.