Money can make a lot of people feel anxious. You may wake up in the middle of the night, wondering if you have paid your bills on time, or what would happen if you lost your job suddenly… Now you’re in panic mode wondering how you would pay for bills and expenses if you did suddenly lose your job. Your heart starts to race, and you can’t get back to sleep for an hour.
Most of us have been there at one point or another. It’s a the feeling known as financial anxiety, and unless you find some techniques to manage financial anxiety, your probably going to continue to stress and end up becoming sick.
But what if I told you there is a simple(ish) solution to help you manage your finances, but also sleep easier at night?
I’m talking about having an emergency fund. The sum of money that is your protection in case anything was to happen.
Lets delve deeper and determine what is a good size for an emergency fund.
How Much Should You Have In Your Emergency Fund?
- An American study
- The emergency fund:
- Emergency Fund vs Paying Off Debt
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An American study
Bankrate’s latest Financial Security Index survey found that only 39% of American adults could cover a $1,000 emergency without having to sell something, or take out debt. That leaves 61% of adults being unable to spare $1,000 in an emergency. One third of Americans would have to take out some sort of debt, with 20% paying with a credit card, 12% borrowing from family and 5% taking out a personal loan.
A further report from the federal reserve continued this trend, finding that 44% of respondents could not cover an unexpected $400 emergency. You can read the report here.
What is an Emergency Fund?
An emergency fund, as the name suggests, is an money savings account that is set aside to cover any unexpected financial emergencies through your day to day life. Emergencies can include:
- unexpected hospital visits
- immediate house fixes
- car break downs
Why do I need it?
Having an emergency fund stops you needing to use a credit card, or worse, having to borrow money to pay for the expense. These costs can add up and can compound if you already have maxed out credit cards or other debt requirements.
Emergency fund size
The amount in your fund really depends on a magnitude of factors such as your current income, ability to find work, current investments etc.
Immediate Emergency Fund
If you haven’t already, you need to save up a couple of weeks worth of pay fast. This could even be more important than paying off debts. A good rule of thumb is to have 2 weeks pay, or equal to €1,000 (whichever is greater) saved up for immediate emergencies.
Related article: 3 Quick Methods to Build an Emergency Fund Fast
We will refer to this as your Immediate Emergency Fund. This fund can help you through minor difficulties such as a small car repair or veterinary emergency. This fund however, will need to be build up more over time. This would be the time to start looking at getting your debts under control.
After your current debts are under control, you can look at saving more into your emergency fund.
Long-Term Emergency Fund
When looking at your Long-Term Emergency Fund, it is important to determine what your (or your families) expenses are. General advice is to save somewhere between 3-9 months of expenses.
The amount you save will ultimately depend on how long it would take for you to find a new job if you were required. If you know you could obtain within a month of losing a job, then maybe 3 months of expenses is sufficient.
If you think it could take 5 months to find work, then it would be wise to have more saved in your long-term emergency fund. You have to ask yourself how long it would take to find another job. That is the amount of money you should then aim towards saving in your fund!
How to build an emergency fund
Creating your emergency fund can be as simple as either depositing a certain percentage of your salary into a separate fund, or by setting up a monthly recurring transfer.
Initially you may only be able to start with small amounts of money (i.e. $10 a week), but that can work out to over $500 for a full year. Also think of placing any tax refund or salary bonus into this fund to really get it started. Any movement of funds into a separate emergency account can help you in the long run.
Where should I store it?
Your emergency money should be easily accessible, but no so accessible that you are tempted to use it for other un-emergency expenses. A good place to store your money could be a savings account through an online bank (i.e. with no storefronts). Online banks generally can offer higher interest, and having no physical building can make it less tempting to withdraw money.
You should not store your money in anything that can loose value, or has your money locked away. Examples of where not to keep your emergency fund
- Stocks or Bonds
- Managed Funds
- P2P or Crowd Lending Platforms
- Real Estate
- Anywhere other than a deposit guarantee bank account.
What can I use my emergency fund for?
Here is where you need to be strong. Your emergency money should only be accessed for (wait for it…..) emergencies.
Paying a repairman to fix a broken television is not an emergency.
Upgrading your car is not an emergency.
Paying Insurance or Rates on your house is not an emergency. These things are already expected
Buying new clothes is not an emergency (unless you have none to start with, then one set may be classed as an emergency, however that’s very unlikely).
Are you starting to get the picture? Only things that are vital in day-to-day life!
If you are struggling with not spending the money, then I you may have to find some ways to improve your money mindset.
Emergency fund or pay off debt?
Here comes the tough question. Do you pay off debt, or do you save for your emergency fund?
Both of these are very important tasks. Choosing which strategy to place your money is very situational dependant, and comes down to how you manage your money, and what debts you have.
For example. if you are paying off 40% interest on a personal loan due next month, it may be more important to deal with that before saving for an emergency. On the other side, if your debts are under control, it can be wise to save up for an Immediate Emergency Fund (~$1,000) before you continue paying off your debts. Generally, the best scenario is to contribute to both paying down debt, and socking away emergency money at the same time.
Saving money into an low interest bank account is counterintuitive when you think about paying off a credit card with an 18% interest. However, you need to be prepared for life. The unexpected does happen.
You may be thinking that I have a credit card, so I am all set for life’s emergencies. Well just wait a minute. Credit cards can provide emergency cash(at a cost), but they should not be relied on in an emergency. The money isn’t always there if you have maxed out the card, or if your credit rating has dropped from past debts.
Depending on whether you choose to save money for an emergency fund or not, a couple of situations can play out:
- You save your funds in an emergency account but don’t need to use them. You must pay a bit of extra interest on your debts and you wonder why you saved for an emergency fund.
- You don’t save for the emergency account and decide to continue paying off your debts. No emergencies occur. You are in the same constant scenario as you were last year. An emergency will happen at some stage, but you will deal with, or take on extra debt when the time comes.
- You don’t save for the emergency account and decide to continue paying off your debts. An emergency happens. You don’t have any money to pay for it as you have been paying off debts, now you need to take out more debt (possibly at a higher rate) to deal with the emergency. You still have no backup and are now in more debt.
- You save your funds into an emergency account. An emergency happens. You are able to cover the amount without having to take out additional loans or borrow money from family.
Overall if an emergency does or does not eventuate, you will be very glad that you have saved that money. You will sleep better knowing you have a backup if something was to go wrong.
Just remember, you are not getting “nothing” when you save for an emergency. You are getting security and protection for when you need it most.
You need to create a spending plan and determine where your funds are going. Your expenses should always be less than your income. If this is truly the case, you should be able to easily allocate money into both paying down debt, and creating an emergency fund at the same time. Once you have created an Immediate Emergency Fund ($1000), you can focus entirely on reducing your debt.
Once you have worked out where your money is coming in from, and going out, it is fairly simple to determine where you should put your money. If you have more expenses than you do income, it is worth looking at either earning more income or cutting down on your expenses.
Each month you bring in $2,000 and have outgoings of $1,800. That leaves you with $200 to spare. You may choose to allocate $100 to paying down debt and $100 to go into the emergency fund. Otherwise you may look at $150 / $50 splits etc. The important thing is to pay them both at the same time.
In the end, its always up to you to decide your risk tolerance and decide what is most important, whether it be saving for emergencies or paying down debt. But, if you have determined your incomes and expenses properly, it should be fairly straightforward to get your money under control.
Hopefully the above has provided some insight into helping you save money for the worst!