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Why is it important to have an emergency fund (and why you need it)?
Life is too unpredictable to be unprepared.
It was a typical Monday morning for John. He went to the office, got on his desk, and started working on his tasks for the day.
Two hours later, his boss rounded up everyone for an emergency meeting.
Without mincing any words, he announced with a heavy voice, “The company is shutting down in a month.”
Everyone was silent. Someone punched his desk. Beside him, a girl was holding back her tears. The boss went on to explain the details, but John wasn’t hearing anything.
His mind is already somewhere else.
He’s now thinking about his wife and two kids, his whole body stricken with fear at the thought of losing his one source of income.
“What am I going to do now? I don’t have a single cent in the bank. School starts next month. Where am I going to get money to pay for tuition?”
It’s a fact of life. Bad stuff happens. A lot more often than we’d expect. One day it’s all fun and sunshine, and then it’s all sorts of problems on the next.
What’s the best thing we can do?
Be ready. Be prepared.
Murphy’s Law states, “Anything that can go wrong, will go wrong.” There’s always that speck of a chance for the unexpected. In John’s case above, it’s losing his job.
What could have made his situation better?
Answer: An Emergency Fund.
What is an Emergency Fund?
Investopedia defines it as “Funds set aside in case of the event of a personal financial dilemma, such as the loss of a job, a debilitating illness or a major repair to your home.”
Pretty simple, right? It’s basically a stash of money with the sole purpose of acting as your safety net so you don’t have to borrow money during hard financial times.
How much do you need to Save?
Before we can determine how much we should save on a monthly basis, we should first figure out a target amount for our Emergency Fund.
It’s measured in terms of monthly living expenses.
For example, if you read that you need a 3-month emergency fund, it means you should save enough to cover for 3 months of your family’s living expenses.
Here’s popular financial coach and mentor Dave Ramsey’s take on this:
- For a 1-income source family = 6-month emergency fund
- For a 2-income source family = 3-month emergency fund
As you can see, for households whose income comes from a single source (like John above), a bigger emergency fund is required. It gives the breadwinner more wiggle time to look for a source of income.
Types of Emergency Fund Accounts
While you’ll find plenty of recommendations online on where to keep your emergency funds, the most important rule to follow is this:
Accessibility over Returns.
An emergency fund should be readily and easily accessible anytime. There’s no sense having one if you can’t withdraw it when you need it, right?
Still, some people, especially those who are in a highly stable earning and savings position, go hybrid and consider the rates of return in choosing where to invest their emergency fund.
With this in mind, perhaps it will be a good idea to break down the different types of Emergency Funds into two categories.
High Yield Bank Accounts
The most popular and recommended “place” to keep your emergency fund. This option provides for the best convenience and ease in withdrawing emergency funds.
Ask your bank for what they offer in types of savings accounts. Most usually have a couple of interesting options that may provide slightly better earnings rate versus a traditional savings account.
Some examples are Money Market and Certificate of Deposits.
Recommended Reading: Best Savings Accounts from the Top Banks in the Philippines
Alternative Options: (Hybrid Investment/Emergency Fund)
As I noted earlier, some people who are in strong financial positions (healthy savings rate, significant accumulated assets) might prefer other options to get the most out of their emergency funds.
They are the ones who may opt to invest this money into low-risk investment vehicles like VUL or even blue-chip stocks for higher potential returns.
The trade-off is you open your emergency funds to risk, so you should be very careful in analyzing the risks involved.
Some folks are in the fortunate position of having all bases covered (has insurance, passive income, owns multiple brokerage accounts, no debt, have a high-profit margin, etc.,) and they will tell you they “don’t need” an emergency fund.
Their current cash flow and various money sources/options are enough to cover 6-12 months of their living expenses at any given time.
If you’re one of these people, good for you, you sure do know how to manage your finances.
How to Build An Emergency Fund
Ready to build your emergency fund? Better get your pen and paper ready (or bookmark this article) because we’ll be showing you the best tips for setting up your financial safety net quickly.
1. Set-up a “Savings system”
Quite obvious, isn’t it? Most people trip on this part though because of one thing: they don’t create a system for saving money.
One popular savings scheme, for example, is the 50-30-20 Rule.
This rule states that 50 percent of your income goes towards necessities (food, rent, bills, etc), 20 percent goes to financial goals (savings, investments), 30 percent goes to wants (entertainment, luxuries).
The great thing about this is you can easily adjust the percentages to accommodate asset build-up for the emergency fund.
You may opt to save a specific percentage (50-20-20-10 Rule) or maybe use a chunk of the 30 percent for entertainment at least until you build up your target emergency fund goal.
Once reached, you can go back to the usual format.
2. Save Automatically
If possible, use an automatic savings option offered by your payroll’s bank which routes a predetermined amount from your paycheck into a savings account.
This provides three benefits: One, you avoid the hassle of manually depositing the money into your savings account. Two, it “safeguards” your money from unnecessary spending (since it will no longer reach your hands come payday).
Lastly, it establishes saving as a habit that can be enforced easily. You literally don’t have to do anything once you’ve set up the auto-save feature.
What if my bank or payroll doesn’t offer that option? If possible, enroll your account into your bank’s online platform so you can easily transfer monies into separate accounts.
The key is to make the process of saving as easy as possible so you can lessen the chances of breaking the habit.
3. Cut down on your expenses
Personal experience tells me that one of the best ways to save money is to cut off certain expenses.
If you take an honest look at your daily spending and get the monthly total, you’ll be surprised at the results.
For example, your favorite Java Chip Frappuccino. At prices of Php 150 to 200, that’s an average monthly expenditure of (150 x 20 days) Php 3,000.
A pretty significant amount if you’ll ask me.
Don’t get me wrong, I’m not saying you deprive yourself.
The point here is to identify areas in your spending that might be draining your budget more than you think and adjust accordingly to save some for your emergency fund.
Have a nice balance between the wants and priorities to make sure it aligns with your financial goals.
4. Increase your earning capacity
Want to save faster?
Or as I call it, “yung sakto lang”. And no, I’m not promoting a “kuripot” lifestyle. It’s all about prioritizing the essential and spending your hard-earned cash on stuff that truly makes us happy.
Why do you always buy clothes when you never wear more than half of your wardrobe anyway? Why stuff your room with all sorts of gadgets and doodads that only gets used once?
Not only do these cost you money, it also clutters up your space. Instead of splurging on random stuff, build an emergency fund instead. It’s way more useful.
6. Track your spending
“What gets measured, gets managed”, said world-renowned management guru Peter Drucker. It’s one of the first steps to take to reach your financial goals.
By knowing how much you’re spending on a particular item or expense, you’ll be made aware of its overall impact on your budget and allow you to adjust accordingly.
It also sets you into the habit of being more conscious when buying stuff, making you think hard if the purchase justifies the money you’ll be shelling out for it.
7. Use Apps and Programs to manage your finances
Our smartphones are always with us so why not leverage them for managing our money?
You might also want to take a look at cashless payment methods like Coins, GCash, Paymaya, and others. Aside from convenience, these allow you to easily track your expenses.
8. Keep ‘em coins
It’s easy to take these things for granted as you see them lying around the house, in your car, on top of the fridge, drawers, pockets, and others.
Best thing to do?
Get a jar. Or a cute piggy bank.
Gather all the coins and make it a habit to throw loose change in there whenever possible. You’ll be surprised at how much that thing will be worth once you fill it up.
Stephen King once wrote, “There’s no harm in hoping for the best, as long as you’re prepared for the worst.”
We’ll never be 100% prepared for anything, but there are ways to improve our conditions should the inevitable happen. And happen they do, for sure.
So save up, build that emergency fund, and keep those worries at bay.