It goes without a doubt, that having some cash at hand can facilitate things a great deal when unexpected things happen. You, or a relative, might get ill suddenly, your laptop breaks down and you urgently need another one, or you get a leakage in your home with needs to be fixed immediately. Surprisingly, many people do not have any cash at hand; they live on a month-by-month basis, fixing sudden expenses mostly via their credit cards or loans.
Having an emergency fund can have great benefits. It has to be admitted, it can be somewhat frustrating to see that money sitting around and virtually doing nothing. But on the other hand, it is reassuring to know, that the money is available at all times when you need it. It can even be used to bridge times in which you might not have a steady income, for example when you are switching jobs.
Supposing you are building an emergency fund for the first time, you may want to consider a few things. These mostly relate to ‘when’, ‘where’, ‘why’, ‘how much’ and ‘who’.
It is never too late or too early to start an emergency fund. Ideally, you will start building an emergency fund as soon as you have some form of income, and when you do not need all of that income to live off. This might mean, that you may need to live very frugally in order to be able to set some money aside on a regular basis.
Even if you do not have a regular and steady income, the more important it is to have an emergency fund available you can build up for times during which you have no income. Especially in the beginning, perhaps with the first regular salary, it is difficult to build the emergency fund. It might be overwhelming to be receiving your first steady salary, and many people start living beyond their standard. Building an emergency fund requires discipline.
When you build an emergency fund, you need to take into account that first of all, the money needs to be available immediately, or at least within 24 hours. Furthermore, the value of your fund should not fluctuate, and you should get out what you put in. For this reason, a savings account is potentially the best option. Each month, you can transfer a small amount to your savings account and let it rest there.
With the current rates, interest is very low. But remember, you are putting this money aside for emergency situations, not to grow wealth. Any form of investments, such as stocks or bonds, are not suitable for building emergency funds, as you might need the money at a point where the market had just crashed, and you would have to sell your investments at a bad price.
Try and define your motivations, why you might need an emergency fund. Perhaps you are having regular health issues, or you have real estate which might need renovation soon. Perhaps you are afraid to get laid off, and you need some money for bad times. When you define what you need an emergency fund for, you can plan better, and you can better estimate how much you need.
Additionally, you can create multiple emergency funds, for different purposes and with different targets. For example, you might want to create one emergency fund with the aim to be able to live without an income for at least 6 months, and another one to cover for unexpected costs on your real estate.
How much do you need to set aside ever week or month? This will largely depend on your goal as stated above, but also how much you earn, and how much you can afford to spare. Maximizing your income with the knowledge you have and reducing your expenses as much as possible are key to potentially setting aside as much as possible.
But perhaps you also have something planned for later this year, like a holiday? It is recommended that you sit down for an hour, and do some brainstorming with yourself about how much you want to build. When you have defined an amount, you can set an automated periodical transfer, so that the bank transfers the amount to your bank account automatically each month. This means you are building an emergency fund without really realizing it, and you won’t forget to make any payments.
For whom is the emergency fund meant? Is it only for you? For you and your partner? Perhaps you want to create a separate emergency fund for your children? Defining ‘who’ is impacted, will also impact the number of funds you want to set up, and the amount of money you might need to transfer. If you are building a fund to, say, bridge a 6-month period without income, it makes a big difference if it impacts only yourself, or your entire family.
Having an emergency fund available can save you a lot of trouble. Emergency funds should be built as soon as possible in life, and they should be thoroughly planned. Emergency funds should ideally contain only cash, which should be available within a very short period of time. The main purpose of having such a fund is to reduce financial risk, and it can pose an extra motivation for people to stop living beyond their means.