Everything You Should Know About Emergency Funds
If you needed £3,000 tomorrow, would you have the savings to cover yourself?
For many people, the answer is no. Why? Because they have not built an emergency fund.
In this post, I will share the importance of having one and how you can start yours today.
What is an emergency fund?
An emergency fund is simply a sum of money you have saved for unexpected financial situations. This may be unemployment, car damage, or medical bills.
It is used as a safety net against borrowing money and reduces the likelihood of unforeseen situations pushing you into debt.
Why are emergency funds so important?
Emergency funds reduce the chances of you suddenly needing to borrow money to survive.
There are many implications of borrowing from partners, friends, and family members. We have likely all seen first-hand the destruction of friendships and relationships due to owing money.
Using a credit card in an emergency is often no less stressful, particularly if you’re worried about how you’ll ever be able to pay off your credit cards.
An emergency fund helps us avoid all the stress and drama that comes with borrowing money. It gives us a new level of independence, knowing that during financial challenges, we can lean on ourselves!
Picture this...
You’re suddenly left unemployed because the company you work for goes bankrupt. It takes three months for you to start your new position and receive your first paycheck.
In this time period, you comfortably cover all your living expenses such as rent, food, and travel. You spend responsibly but are still able to afford a few nights out with your friends.
You avoid unnecessary debt and the additional stress that comes with searching for last-minute financial support.
You experience first-hand the power of an emergency fund.
The difference between general savings and an emergency fund
Having savings does not mean you have an emergency fund. This is something I took a while to realise.
I have a separate bank account where I save towards my house deposit. In emergencies, I would use these savings to cover myself.
This was before I realised that my general savings is not my emergency fund! Every time I would use my house deposit savings to cover myself, I was undoing the progress I had made towards my bigger financial goals.
Having an emergency fund stops us from sacrificing those goals to get out of difficult financial situations. It took me a while to realise this, but now I finally understand.
How much should my emergency fund be?
The total amount that your emergency fund should be varies from person to person. It is largely dependent on your monthly expenses and level of risk.
For example, if you have children or financially support other family members, your emergency fund should be significantly higher than someone who has no one financially dependent on them.
Another example: if you have a known health condition that has a high risk of leaving you out of work for long periods of time, your emergency fund might be significantly higher than someone financially similar with a low risk of being out of work.
To calculate how much your emergency fund should be, calculate your monthly bills and expenses, remembering to add a bit of padding. Times this number by the total number of months you’d like your emergency fund to cover you for if you are out of work.
Typically, this is for at least three months, but the longer you can protect yourself, the better. Use this free worksheet to calculate how much your emergency fund should be.
How to set up your emergency fund
1. Open a new bank account
2. Work out your monthly payments
Once you have worked out how much your emergency fund should be, decide how long you are giving yourself to reach this number. You can work out how much you need to contribute each month by dividing the desired total of your emergency fund by the total number of months you’d like to save towards it.
Remember to pick a realistic timeframe that you honestly believe is achievable.
3. Start saving
Saving for your emergency fund should be treated like paying another monthly bill. Once the money is gone, it can never be touched again (outside of an emergency, of course)!
Set up a monthly standing order for your emergency fund account. The money should be instructed to come out as soon as you get paid, as this will reduce the temptation to overspend.
The faster you build your emergency fund, the quicker you are protected! So start saving today.