A money stored or set aside when something unexpected happens
An emergency fund is money stored or set aside when something unexpected happens.
Imagine you were sleeping, but suddenly your partner or kids needed to go to the hospital. Some people may have enough money to afford that, and others might find it out of budget. That's where an emergency fund comes in handy.
It is a money or a highly liquid asset set aside when people are experiencing financial problems or unexpected expenses.
The purpose of this fund is to increase financial security by setting a safety net that can be used for an unexpected bill.
Having these funds reduces the needs and costs related to high-interest credit cards or personal loans. Backup funds can also be used for future security by allocating retirement funds.
What kind of emergency?
This kind of fund deals with unexpected expenses and financial problems, such as:
Unexpected medical or dental problems
Major home expenses
Sudden death or disability in the family
Unplanned or unexpected travel expenses.
All of the types that are mentioned tend to cause unexpected accidents that may occur. For instance, if someone had an accident, they would have to pay for the medical bills and automotive repairs.
Furthermore, nowadays, many people are going into unemployment because of Covid-19. Many people lost everything because of this pandemic, especially with the high mortality rate that came with the disease. Covid-19 also increased the unemployment rate, as many people lost their jobs.
People will likely fall into debt during such tough times, especially if they aren't financially prepared for such incidents. Therefore, they could be taking loans from banks, using credit cards, or personal loans from friends and families.
A backup fund should also include basic expenses like house rent, grocery expenses, electricity bills, phone bills, etc. Setting aside your backup fund while also planning your financial activities is recommended.
Why are emergency funds important? This type of fund creates safer financial situations to keep you afloat without relying on debt, credit cards, and high-interest loans. Even though those funds must be able to pay the debt, it is better to stop borrowing money, which could lead to having more debt.
Using these funds is helpful when individuals are prone to financial problems, just like societies worldwide experienced in 2020, from lockdowns to major economic crises. This is why preparing these funds and staying ready can bring a little bit of comfort during unexpected situations.
Benefits of having emergency funds
1. Helps keep your stress level down
Preparing these funds helps to keep our stress levels down. When you are stuck in a situation that threatens your financial situation, it could cause stress and even depression. These funds create a safety barrier that could prevent you from falling off a cliff.
2. It keeps you from spending on a whim.
Keeping and storing these funds prevents us from buying unnecessary whims. Let's say you wanted a new big smart TV or wanted some high-quality clothes that could cost $100. If these funds are easily accessible and used to buy the things you want, it wouldn't be considered an emergency, right?
Keeping the money in a safe place or preferably out of your range keeps you from spending it on a whim. The easiest way is to make a bank account for the funds and store them, as it helps you track how much you save and how much you have.
3. It keeps you from making bad financial decisions.
Even though you have set your backup fund, and are still taking loans or using credit cards, then you are probably going to spend more than what you need. Having interest rates, fees, or even charges is just going to keep you from having a successful fund.
How to calculate your funds?
An easy example: start small, maybe set aside around $500 every month, then try increasing the number as your financial situation improves.
However, setting funds means adjusting to your current financial situation and future planning. A good rule of thumb is to cover your essential expenses for three to six months. The purpose is to cover your expenses if you lose your job.
While looking for another job, the funds keep you safe for up to six months, and you should use them for expenses only. In the meantime, you can always look for a side hustle. Even if you're starting small, it's better to start small than with nothing.
If you could save more than $500, it would be better: the bigger, the better. Even having $500 saved each month can get you out of many financial scrapes. Put something away now, and build your fund over time.
To help better understand what an emergency fund is and how to implement it in your life, here are some examples.
A small family consisting of a married couple and two kids has an expense of $6000 every month. These expenses consist of bills such as water, electricity, groceries, mortgages, car payments, schools, and a lot more.
If they are facing unemployment and receive no income, they should prepare the funds. The rule of thumb is to have the funds for 3-6 months. If they are planning to save for three months, they should save $18,000 to sustain their lives for the next three months.
If they are experiencing six months, they need to prepare $36,000 just to sustain their lives. And this applies to everyone who wants to save up to 9 months or maybe even one year.
If possible, have another source of income. If you have a steady 9-5 job, it's great because you have a stable income. Although saving up to $20,000 could be challenging, it could take a very long process just to reach three months. So having another source of income could be better.
Imagine a house was built based on one pillar for its foundation. Take that pillar, and everything is going down; it will break quickly. If a house stands from 2 or maybe even four pillars, taking the pillars one by one, the house would still stand until the last pillar is taken.
Now imagine, if those pillars are your income, having one income is great and sustainable, but it will take a long process to have a sustainable life in unexpected situations. Therefore, having a few sources of income would sustain your life even further.
Maybe have a side job or a side hustle like small businesses that could create a better, more stable financial situation.
How do I start?
Setting a backup fund can be accomplished in a few steps:
1. Set an emergency savings goal:
It could be $30,000, depending on how much is your monthly expense and how much can you save
2. Determine how much you can put away each month, whatever amount that you are comfortable with
3. Pay yourself first before other expenses are paid each month (as long as you have enough income to cover your total monthly living expenses)
4. Stick to your plan, no matter how tempted you may be, to use emergency savings for another purpose.
Saving money and having quick access could be tempting, so always consider the things you need.
5. Save unexpected income.
Receiving a bonus, or getting a tax refund, or coupons could help you reach your goals.
6. Always save money even if you reach your goal.
Emergencies can vary; someone could be hospitalized for three months or unemployed for five months.
7.Having more than one income (if possible)
But before doing all the above, make sure that you are managing your funds: it would be impossible if you have your income but spend it on liabilities, bags, shoes, or maybe even smartphones. It's just stalled your emergency plan.
If you can manage your funds, then you could prepare the funds whilst saving money on the things you want to spend.
Where should we save our emergency funds?
There are some ways to keep your funds.
High-interest rate savings account and quick access. Emergencies could happen anytime. That's why it's called an emergency, so having a quick access saving account would be crucial. But the funds should be separate from your daily use account, as it prevents you from using it bit by bit.
A high-yield savings account. The money earns interest, which pays a competitive rate of return. You can get it fast, whether you withdraw money or transfer money. It's also insured by the federal government, so it's secure.
Online banks are also a good option for this fund. They typically offer higher yields and charge lower fees. This also separates your main funds from your backup funds.
If some people are more comfortable saving in cash, make sure they have secure savings and commit to not using them. It's probably better to store your cash in a safe-deposit box, or somewhere you can't have easy access to it but still be able to take it when it's urgent.
Whatever it is, make sure always to set aside your income for your emergency fund. Having a separate account or storage helps you track your funds and prevents you from using them, whether inadvertently or on purpose.
Whatever you choose, the most important thing is to save and just don't use any of it. Whether it's a savings account or cash, pick what is the most convenient for you and commit not to touch it.
Insurance vs. emergency funds
Insurance means protection from unexpected loss.
It is a written contract between an insurer and a customer for which a company or insurer must protect the customer from financial losses. It is a company that manages risk, and they are used to handle unexpected or uncertain losses.
Insurance companies provide a variety of insurance, from individuals to groups such as families. Insurance is made to protect customers in the event of an accident or losses that customers cannot pay.
Let's say someone had d a car accident and requires surgery because of the accident. The event's outcome requires him to pay $15,000, which he doesn't have at the moment. This is where the insurance company takes charge and pays the hospital expenses, car problems, etc.
Now you might ask yourself what is better: insurance or emergency funds? Every choice has its pros and cons. In this situation, which is best?
The pros of insurance are calculated expenses. Insurance companies provide monthly payments depending on the customer, and they could offer from $30 to $500 every month.
And even if you just started using insurance and the next month you have an emergency, the insurance company will cover it.
Investing in insurance protects from accidents. Nonetheless, insurance companies take a lot of time when it comes to hospitals and have a lengthy process when reimbursing them.
Because it is a lengthy process, you cannot just withdraw the money you have invested in the insurance company. Insurance doesn't cover all expenses, and there are some conditions where insurance doesn't cover all the necessities.
Another frequently asked question is, if insurance covers unexpected losses, do we still need emergency funds?
Yes. The priority is to build the funds. The funds are money that has been set aside to prepare for unexpected situations. The funds cover all aspects of necessities. From medical fees, rent, groceries, education, car payments, etc., while insurance only covers medical emergencies.
Saving money for emergencies is different from having insurance because paying an insurance company is more expensive because you have a specific amount to pay even though you are being covered.
The best case is if you could afford an insurance premium and still be able to save money for unexpected situations. This will help a lot in the future.
The difference between insurance, emergency funds, and saving funds
A) Insurance is a company that provides a financial backup if something occurs. It covers most accidents and medical bills, but not everything is covered by insurance, such as unemployment or a very small medical bill.
The great thing about insurance is that it helps your financial plan, which could give you options to pay your insurance based on your capabilities.
B) A saving fund is an account for a specific goal. Both of them are money that is being set aside to reach particular goals. If one is for emergencies, saving funds are for targets or items you want to buy.
Saving funds is not a priority, so it's better to prepare the other funds before really making saving funds.
Saving funds are:
Future college tuition
Personal funds. For instance, buying a house, a new car, or holidays. Etc.
C) An emergency fund, as mentioned above, is money that is set aside to prepare a person if something bad happens. If someone didn't prepare this fund, it could be very rough living in the next few months. The examples of the fund are:
Swollen medical bills
Natural disaster. Etc
A cash reserve set aside for unexpected bills or financial emergencies is known as an emergency fund. Car repairs, home repairs, medical expenditures, and a loss of income are all classic instances.
Emergency savings can be used for large or minor unexpected debts or payments that are not part of your regular monthly expenses and spending.
If you are lucky enough to have a sustainable life, always have a positive net worth and be prepared for everything.
Not all days are rainbows and sunshine, and there are going to be difficult days that we should be prepared for. There are many ways to store your backup fund: bank accounts, online banks, or just stored cash.
Insurance does help cover incidents like injuries, medical bills, and operations, but not everything is insured by the insurer. In addition, savings cannot be mixed with backup funds, and it will create a blur in the transaction history, and tracking it could be difficult.
When you reach your goal, keep saving money. Saving more and more money increases your wealth for the future. If you are not facing any problems right now, it would be a good idea to transfer some of your funds to your retirement savings.
Whatever social level you belong to, whether a low, middle or high class, always have an emergency fund and constantly try your best to manage your financial situation, as it could save you from the biggest catastrophe.
Frequently Asked Questions (FAQ)
The rule of thumb is to be able to sustain your life for 3 to 6 months.
Depending on your situation, it is always better to have more funds available.
It also depends on your job availability. Is it easy to look for your position or not?
Well, not really. It depends on your monthly budget and how much you are comfortable putting aside your funds.
It depends on your situation. If you save a lot of money, you could use it for your retirement plan, but it is still best to keep some money for emergencies.
It is better to clear any other expenses that might eat your money. If you have high-interest debt, that should be cleared first, as it disturbs your financial situation. It's better to save money than to have still to pay debts.
If some have a lower wage income, it's still best to prepare this kind of fund, but it may be harder than for people who have a minimum wage income.
You could save your funds in stocks, but usually, stocks have an annual return rate, and some may vary from 10% to 25%. Just make sure you keep saving it and have quick access to it.
If people have managed to reach their goals, try to consider other options to expand your funds.
Buy a plane ticket for an interview. In today's circumstances, online meetings are available, probably preparing for a job transfer.
Choose a more reliable and newer car for long-term use.
If you own a property, try fixing small things in the house to keep the house in shape.
However, remember that this option is more of a lifestyle, it's not urgent, but it does help for long-term use.
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