“You should build an emergency fund.” This is one of the common pieces of advice that you will receive from financial advisors or coaches in building your wealth.
You will frequently heard about it also from people who are making an effort in increasing their financial intelligence.
Are you wandering why it is the common denominator among them?
If you are not that familiar about emergency fund. Here is the guide about it. Let us have a thorough discussion.
This article will address the following questions:
- ) What is an emergency fund?
- ) When to use your emergency fund?
- ) What are the reasons why you need an emergency fund?
- ) How much should you save for emergency fund?
- ) How to build an emergency fund?
- ) Where you should put your emergency fund?
Let’s start.
What Is An Emergency Fund
An emergency fund is the amount of money that you set aside in case of emergencies that need immediate action. Emergencies can be a loss of income, house repair, car trouble, and hospital bills to name a few.
It is a different account intended ONLY for unexpected expenses since it acts as a safety net so that you do not need to borrow money. In the simplest definition, it is the money that can save you during a crisis.
When To Use Your Emergency Fund
I have mentioned earlier the sole purpose of an emergency fund. But it is not that clear regarding when you can actually use one. Now, let us set a definite scope on when you can use your emergency fund.
What is an emergency? Anything that is unforeseen and can directly affect your life, health, and your ability to earn money. Some but not limited to are job loss, illness, and the death of a family member.
What is not an emergency? Anything that can be prepared. Birthdays, buying the latest gadget, travel expenses and alike.
IF you are still in doubt, ask yourself the following questions:
- ) Is it unexpected?
- ) Is it absolutely necessary?
- ) Is it urgent?
Three “yes”? Then feel free to use your emergency fund. You can refer on Dave Ramsey blog for more details.
Reasons Why You Need An Emergency Fund
Having an emergency fund can help you to avoid borrowing money. You do not have to resort to using your credit card or in applying for a loan with a high-interest rate. Here are some additional reasons why you need to build an emergency fund immediately.
1.) You only have one source of income
In a case out of many different income streams you only have one, your emergency fund can serve as a lifeline. Especially, if you are relying only on your job salary and you are the breadwinner.
There is no assurance of how long you can stay in your job. How confident are you that you will not lose your job especially during a recession? And if you relieved from your occupation, do you have any back-up plan?
Your emergency fund, for the meantime, will provide your financial needs. And hopefully, it is enough until you will able to look for another job.
2.) You just initiated making a budget
If you just recently started making a budget, it cannot be avoided that there are some expenses that you will overlook. It is okay, you are just starting and you are on the way of making it “perfect”.
Temporarily, you can use your emergency fund for the expenses that you missed. And, take note of the expenses that you missed and do not forget to include it in your next budget.
3.)You are self-employed or a contractor
If you are a contractor and your contract just recently ended and without being renewed, you can use your emergency fund for your daily expenses. Hopefully, you can immediately find a new job.
On the other hand, if you are self-employed we know that you do not have a stable or fixed monthly income. That’s why, during your low earnings, your emergency fund is your back-up for your daily expenditure. It is also important that you know how to make a proper budget if you have an irregular income.
4.) You are far from your family
If some emergencies arise and you need to go home immediately, you can use your emergency fund for your fare. Or, to send it to your family to pay the hospital bills or for buying medicines.
5.) You are the homeowner
It cannot be avoided that there will be some repairs needed in your home. Instead of thinking where will you get money for paying house repairs, your emergency fund will take cover on it. By this, your money intended for other usages will not be affected.
6.) You are saving money for your other goals
We know that we have also some other financial goals in our lives. This can range from treating ourselves to other beautiful places, buying gifts for our loved ones, or for our dream house.
Because you have an emergency fund, your other money intended for your other goals will not be affected.
7.) You have a medical or health issue
Frequent going to hospitals or health clinics can really have a big impact in your pocket. Even though you have health care or health insurance, it may be not enough to cover the expenses. Or it may not even be covered by your insurance policy.
How Much You Should Save For Emergency Fund
Now we know the importance of emergency funds and when to properly use it. That it is a recommended must-have by financial experts and a part in building our financial foundation.
The next question will be, “How much should I set aside?”.
When can we say that we already saved enough? There is no exact amount. It will vary from person to person and with your present situation. It depends on many factors – single or married, monthly expenses or earnings and many other things.
But, here are some of the tips from financial experts regarding on how much emergency fund you should have.
According to Learnvest Rule 3/6/9, we should base on our current situation. This is how you apply this rule.
When 3 Months of Take-Home Pay May Be Enough
If you are single, a renter, you have only your mouth to feed, and have a stable income. Your emergency fund should be equivalent to three times of your take-home pay. Let’s say the amount you received after all the deductions in your salary is Php 20,000. Then, you should have Php 60,000 as your emergency fund.
When 6 Months of Take-Home Pay May Be Enough
If you are married and with kids, a homeowner, you and your partner have a stable income. Your emergency fund should be equivalent to six months of the highest take-home pay.
For example, you are earning Php 20,000 monthly and your partner has a monthly income of Php 25,000. Your emergency fund is equivalent to Php 150,000. This rule also applies if you are married but you do not have kids yet and still paying your mortgage.
When 9 Months of Take-Home Pay May Be Needed
If you are married and one of you is self-employed, you should aim for nine months equivalent of your average take-home pay. Since there are months that are gainful while other months are unprofitable.
Some also suggested that you need also to put into consideration the unemployment rate as a factor. For example, the unemployment rate in the Philippines is 5.3%. If you have monthly expenses of Php 20,000 and taking 5.3 as a factor, your emergency fund should be Php 106,000 (Php 20,000 x 5.3).
Dave Ramsey, a popular financial coach, and mentor also has his personal take on this. For a one income source family, a six months worth of monthly expenses will do while for a two-income source family three months will do.
However, the most common advice is it should be equivalent to three to six months or your monthly income or expenses.
There are many different ideas on how much you should have for an emergency fund. But in general, the less stable your income is the more you need in an emergency fund.
Where You Should Put Your Emergency Fund
You already decided on how much you set aside for an emergency fund. The next step is to identify where is the best and worst place to put that money.
Things To Consider In Choosing Where To Put Your Emergency Fund
1.) Accessibility
The main purpose of an emergency fund is for emergencies, right? Thus, your emergency fund should be put into where it is readily and accessible anytime. You defeat the purpose of having an emergency fund if you cannot access it when you need it most.
2.) Safety
Your emergency fund should also be in a safe place. But not so safe that even you will have a hard time accessing it. Just safe enough that unwanted persons cannot get a hold of that money.
3.) Volatility
Volatility means a tendency to change quickly and unpredictably. An emergency fund should not be put to a very erratic account or investment. Since higher volatility means higher risk. This also means the higher the chance you will lose your money.
4.) Interest Rate
There are still people who consider the potential growth of their money. And there is a valid reason for this, inflation. Putting your money in a no or very minimal interest rate can lower the buying power of your money.
However, REMEMBER to always choose accessibility over earnings. After all, an emergency fund is for emergencies and not for your money to grow.
Wrong Places To Put Your Emergency Fund
1.) Life Insurance (VUL)
Putting your emergency fund in life insurance with investment is not a good idea. Yes, your money can grow faster compared to the bank. But? If you lose your job, the insurance company will not cover your daily expenses. If you have some unexpected home repair, your life insurance policy will not cover the expenses. The purpose of life insurance is for your family if disability or death happens to you. This can serve as an income replacement.
2.) Stock Market or Aggressive Type of Mutual and UITF Funds (Equity Fund, Balanced Fund)
Though it is easy to withdraw your money from mutual funds or UITFs account and has also a higher potential growth, it is volatile and unpredictable at the same time. Market performance cannot be predicted thus the chance of losing your money is possible. When you need money but the market performance is not good, you have no choice but to sell your shares at a lower price compared when you buy it. You lose money in the process.
So, here are the places to consider where to put your emergency fund.
Good Places Where To Put Your Emergency Fund
1.) Bank Savings Account
It is safe since it is insured by PDIC – deposits are insured up to Php 500,000 per depositors. It is very accessible also as long as there is an ATM terminal in the area but has a low-interest rate.
Of course, you should open a separate saving account intended only for your emergency fund and leave it alone. This way, you will not be tempted to withdraw from it.
2.) Time Deposit Account
It is similar to savings account however you keep your money for a period of time without withdrawing it. It is also PDIC-insured but has a higher interest rate compared to a regular savings account. But it is less accessible compared to a savings account since there is a lock-in period.
3.) Mutual Fund or UITF (Fixed Income Fund)
Putting your emergency fund in a mutual fund is not totally bad at all as long as you pick the conservative types of mutual funds. A fixed income funds are primarily invested in government securities, bonds and commercial papers, deposit products and other instruments.
Opening a mutual fund or UITF account is easy and no big amount of money is involved. The same thing with topping-up your account.
4.) Cooperative Savings Account
A cooperative is a duly registered association of persons who have voluntarily joined together with a primary objective to help improve the quality of life of its members. Currently, there are 21 types of cooperatives in the Philippines. You can learn more about cooperatives here.
5.) Home
Stacking your emergency fund in your home is okay as long as you only keep a portion of it. And be sure that you set it in a place where it is really safe and only a selected few knows about it.
Just an additional tip, you can opt not to put your emergency fund in just one account. For instance, you can set aside a small portion of your emergency fund at home. A larger portion to your savings account and some to a more high-yielding interest rate like in mutual funds or UITF. However, always remember that an emergency fund is for emergencies only and not for your money to earn a decent amount.
Steps On How To Build Your Emergency Fund
After taking many things into considerations on how much your emergency fund should be and deciding where to to keep it. The next step is for you to build an emergency fund now.
1.) Decide how much should be your emergency fund
You need to set how much is your emergency fund basing on the mentioned pieces of advice above. The importance of really having a value is for you to be able to assess how close you are in attaining your goal and to make necessary adjustments along the way.
2.) Include it in your budget
Check your cash flow and assess how much you can set aside for your emergency fund. Include it in your budget and treat it as one of your priorities. Cut down also your expenses if you must.
3.) Open an account
Decide where are you going to keep your emergency fund. Is it in regular savings account or in a mutual fund? Or, in more than one place.
4.) Save automatically
After opening an account, save automatically. You can do this especially in bank savings account. It is better to automate financing your emergency so that you can build it within your targeted period of time. You can also assure that you are building it continuously.
5.) Increase your earnings
If you are having a hard time saving for your emergency fund, increase your cash flow. Look for additional income streams. It is also good that you are not relying only on one source of income.
6.) Assess and adjust if necessary
Along the way, do not forget to track. Evaluate how are you performing and make necessary adjustment if you have to. Are you still within your targeted time frame? If not, what is the reason and what can you do to cope up?
To be able to build an emergency fund as soon as possible is really good. This will give you a peace of mind that you are prepare when emergencies will happen.
However, if you are having a hard time building it, do not be discouraged. Just build it gradually. Having a small amount of emergency fund is better than having nothing at all.
Bottom Line
An emergency fund is an essential step in building our wealth. It keeps us more worry-free and confident that when unfortunate events will happen we have a back-up. And yes, emergencies really happen and you will not know when. All we can do is to be prepared!
That’s why, you must build an emergency fund as soon as you can!
Do you have any additional tips regarding how to build an emergency fund? Or anything about the emergency funds? Share it in the comment section below.