Have you ever had an unexpected life situation that threw you off balance in terms of finances?
If yes, then let me introduce you to an emergency fund.
There are unexpected curve balls that life throws at you every day.
If you are faced with an emergency and the first thing is to run to your friends or family to borrow money, ask for a loan from the bank or liquidate your assets, then you will most likely head to a financial disaster.
It is important to have an emergency fund for emergencies so that your financial status may not be impacted by these financial blows.
You have to be aware and ready for these emergencies and combat them before they can ruin your current financial position.
When I was jobless and penniless, I wished I had some cash cushion.
We’re not taught in school about an emergency fund, we’re ONLY taught about getting employed and saving.
We’re also taught as adults that having an emergency fund with at least 3-6 months’ savings is enough.
How wrong and crazy is that?
It took me 3 years to get a job and even then, it took me years to become financially secure.
I had to relearn about money, emergency funds, savings, investments, debt and debt payment, and a money mindset.
And this learning is an ongoing process.
Why do we get advised to have a little emergency fund when we need a lot of it?
Think of an emergency fund as a cash cushion to help when things go awry.
An emergency fund is used for emergencies but you can always expand the use – it’s your money.
You also need a lot of discipline to have an emergency fund.
You may be wondering where do I get school fees for my kids or where do I get money for that school trip or that instrument my kid was asked to have in school?
It’s not the end month and we haven’t been paid, that’s what an emergency fund is used for.
But, there are other cases like a death or emergency hospitalisation, where do you get the money to deal with this?
Have an emergency fund.
You cannot use your emergency fund to buy a car – a car isn’t an emergency unless you are in the car business and quickly need to fund for a car instead of buying on a loan.
Look, your emergency fund can be used for when you get sacked.
How many people got sacked during the pandemic?
Do you have a job or are you still hunting?
How many years or months has it taken you to find another job?
SAVE and have as much money in your emergency funds account as you possibly can.
And don’t get cheated, you can choose to invest your emergency fund.
Your emergency fund doesn’t have to sit idle in the bank or savings account – I hate money that doesn’t work.
In this article, I will go over what an emergency fund means and also give examples.
I will also talk about how you can build your emergency fund and the best places to keep this money.
Most importantly, we will look at the reasons why having an emergency fund is important.
What is an Emergency Fund?
An emergency fund is money set aside to act as a cushion in a situation where you are faced with an unexpected financial situation, for example losing your current source of income.
Life has a tendency to throw unexpected curve balls at us, so you need to know how to prepare yourself for these unexpected events by having an emergency fund.
An emergency fund is referred to as a rainy day fund.
Why Do You Need an Emergency Fund?
There are many life scenarios where uncontrollable circumstances occur.
An emergency fund will come in handy for you if you prepare yourself.
These are some reasons why you need an emergency fund and they include:
- You may lose your job and need to live off your days before you get your next job with an emergency fund. An emergency fund will help you in case of irregular remuneration too.
- You may have a medical emergency that you need to take care of
- You need an emergency fund to help you foot unexpected bills like funeral arrangements.
- You need an emergency fund to help you pay off your debts
- You need an emergency fund to prevent you from selling off your valuables to cater for your expenses.
- You need an emergency fund in case of a car break down, or your child hits a neighbour’s window or car.
- Buying a birthday gift or preparing for a bachelorette party.
You can use your emergency fund for those ‘rainy days’ which means you can expand this list.
How Do I Build an Emergency Fund?
How do you get money to build an emergency fund?
The following are ways to build your emergency fund and they include:
- Track your monthly expenses
- Set up a monthly budget
- Increase your income by creating a side hustle
- Set up a standing order with your accounts.
How Much Money Should I Keep in an Emergency Fund?
The amount of money you need to keep in your emergency fund will depend on the type of job you are doing.
For starters, financial experts advise that you need to have at least 3 to 6 months of living expenses 6o cater for you in case of an emergency.
However, I tend to disagree with 3 – 6 months of emergency fund savings.
Depending on your job and the job market, it may take longer than 6 months to find another job or even start a profitable business.
I’d suggest having at least 20,000 dollars/2M+ in your emergency savings.
You can always take an additional job like bartending or babysitting or housesitting to quickly build your emergency funds.
Or you can utilise your skills (you have in your current job or acquire new skills) to help you build an emergency fund.
Having an emergency fund requires you to look hard at your finances and develop the discipline to save.
Some people may call an emergency fund a scarcity mindset savings because it appears as though you’re waiting for disaster to happen, but it’s not.
You’re preparing for the unknown.
What are the Best Places to Save an Emergency Fund In?
There is a lot of controversy about where you can keep your emergency fund.
Do you keep it in your checking account?
It is important to note that an emergency fund is not investment money.
An emergency fund is supposed to sit.
It has to be kept in a different account from what you are using.
You need to keep an emergency fund in a quick to access account – no restrictions.
Here are some of the best places to have your emergency fund.
High-interest savings account
A high-interest savings account is one in which money deposited will earn a higher interest rate than with traditional bank accounts.
High-interest savings accounts are usually found in online banks and before you put your emergency fund into this savings account, you need to check the rates offered, fees, rules and any other perks.
A money market account
This type of account is similar to the high-interest savings account, except that you have to put in large deposits of cash as emergency funds.
You also have to do thorough research on these money markets before you pick one to put in your emergency funds.
Consult with an expert if you don’t know.
A traditional bank account
A traditional bank account is the brick and mortar bank we have around.
You can go to the bank and open a separate account from your savings or checking account and have that as your emergency fund account. You will be earning interest on this money depending on the rates offered.
I consider traditional banking to be very effective in case of risk.
A retirement account
Although this still brings up a lot of debate, you can place your money in a retirement account.
You will be earning interest with your money as you secure your financial future.
You also have to be financially disciplined if you are going to take this route.
A certificate of deposit
This is where you keep the money for a given period of time, after which you will receive a guaranteed rate of return in exchange.
A certificate of deposit is also a good option you should consider when looking for the best places to keep an emergency fund.
Why is Having an Emergency Fund Important?
These are some of the benefits of having an emergency fund and they are:
- It will give you peace of mind
Are you constantly stressed or worried about what you would do in case of an emergency?
If you are, you need to have an emergency fund.
This is one of the most important reasons to have an emergency fund. Study shows that people who have emergency funds are happier and more fulfilled than those who don’t.
When you have an emergency fund, you will not have to think about any impending catastrophes that might change the trajectory of your financial life.
You know that the situation is going to be handled effectively. This peace of mind will make you live life better.
- Life-threatening issues become slight inconveniences
There are big emergencies and small inconveniences.
Emergency funds have proved that.
If you have, at any point, had a life-threatening emergency, like, say, a person you know is committed to the Intensive Care Unit and you had to raise large sums of cash for their surgery, then you will understand the importance of having an emergency fund.
When situations like these arise and you have an emergency fund, it will be easy to dip into it and give all the help you can without feeling overwhelmed or financially burdened.
- Your assets will be protected
Sometimes when we fall into a huge debt that we cannot pay off, or need to raise cash to get something we need immediately, we may tend to sell our valuable possessions to make these ends meet.
It doesn’t matter if they are unwanted or wanted.
Assets help to improve your net worth and if you keep selling them, then chances are you are heading to a financial disaster.
It is important for you to understand that having an emergency fund will give you a cushion to prevent you from selling your assets.
In case of a financial crisis or a financial dilemma, you can dip into your emergency fund and “save” the situation. Your assets will be protected this way.
- You can achieve your financial goals
Having an emergency fund is important because it helps you achieve your financial goals.
If you are saving money for a certain thing, you don’t have to worry about dipping into your savings when disaster strikes.
Your savings are kept separate from the emergency fund.
You will only use your emergency fund to help you in cases of emergency.
If you can save without diverting your money to other areas of need, you will be able to meet your money-driven financial goals.
An emergency fund will help you stay focused and you will be more intentional with your finances.
- Helps you secure your financial future
This is another reason why having an emergency fund is important.
Your future self is financially secure. I always say this: any wise person should value their future self more than their current self.
One of the ways to do that is by having an emergency fund.
People who live financially stable lives in their prime years attribute their lifestyle to always having an emergency fund in case money demanding situations occur in their lives.
They always ensured that by no means they’d take out money from their retirement savings to meet these needs.
This is how they secured their financial future.
- Helps you set your priorities
An emergency fund is important because it helps you set your priorities.
There are situations that are deemed as emergencies and those that aren’t. In that same line, there are emergencies that are more important than others.
You need to prioritise your emergencies because not every situation calls for you to take out money from your emergency fund.
For example, if you go out shopping and you forget your shopping money, that is not an emergency.
You are not allowed to dip into your emergency fund.
On the other hand, if your son hit a neighbour’s car window, then that is an emergency and you need to pay for the damages as soon as possible.
- Helps you pay off debt
Having an emergency is important because it will help you pay off debt.
How? The first way that an emergency fund will help you pay off debt is by preventing you from getting into it in the first place.
Life happens and when it does, you don’t have to run off to your friends, family or the bank to get loans.
You may end up signing up for high interest-earning debts that will dig you further into the financial pothole.
With an emergency fund, you are able to handle your situation with money that is not borrowed.
Secondly, you can also use your emergency fund to pay off urgent minor debts.
- You only have one income
An emergency fund is important when you have one income.
Despite the fact that it is unwise to rely on only one job, that is the reality for most people.
If you only have one source of income, an emergency fund is important to you.
There are unexpected life events that will be thrown at you and you need to know how to combat them.
In case you get fired or laid off from your current job, how would you survive?
Will you be living off borrowed money until your next job or will you have a cushion to absorb this financial shock?
If you have no plan when this happens, consider getting an emergency fund. It will be better for you this way.
- Financial confidence
Financial confidence is the state of being aware of your finances and having faith in yourself that you are managing money effectively.
Nothing can bring you financial confidence more than having funds set aside for unplanned life events.
You will feel more in control of the situation and your finances.
You will not be worried, stressed or too afraid of unexpected happenings.
You will be financially prepared.
- You get extra earnings
An emergency fund is not an investment but it can be.
My need to make money work for me cannot stop me from thinking of ways to grow an emergency fund.
Don’t think you will take out money from your emergency fund and then invest it into other areas for high returns.
An emergency fund is supposed to just sit.
Now, I know there are lots of contrary opinions on this, but the fact still remains.
You can have your emergency fund in a high-interest saving account and earn some extra income.
Getting extra income with your emergency fund should be on your to-dos.
- Prevents impulse spending
To have an emergency fund, you need to know your needs and wants.
This is important because you have to reduce buying items on whims if you want to build your emergency fund.
Spending your money anyhow cripples you with debts and bars you from building an emergency fund.
An emergency fund is important because it will help you to reduce your impulse buying habits.
- You cut back on expenses
Cutting back on expenses is very important when you want to build an emergency fund.
If you are overspending, you need to take a step back and start keeping track of your purchases.
Your expenses are one of the reasons why you don’t have an emergency fund.
Again, you need to know what you need and what you don’t and cut off these extra expenses.
You will be able to build and maintain your emergency fund when you do this.
Financially successful people have talked about having an emergency fund helping them to cut down costs.
- It protects your savings.
Lastly, having an emergency fund helps you protect your savings.
Dipping into your savings to cater for money demanding financial situations is a bad idea.
Your savings are for investment or for accomplishing your financial goals.
Savings aren’t for use in life-threatening situations or paying off debt.
Having an emergency fund is important because you will not be thinking about using your savings when you have a financial crisis.
You will only focus on saving towards your financial goals.
FAQs on Why an Emergency Fund is Important
The following are frequently asked questions on the importance of an emergency fund and they are:
Why is it important to have an emergency fund?
Emergency funds help you handle unplanned expenses without hindering your financial stability or increasing your debt
Reduce stress level
Encourage saving behaviour
Avoid bad debt
What’s a good emergency fund amount?
A good emergency fund amount is 2 years’ worth. 3 – 6 months doesn’t cut it.
How and where do you use your emergency funds?
You use your emergency funds on
A lot of us make the mistake of dipping into our savings when things start going south financially.
Either that or going around asking for money from banks, family, friends and even selling your assets.
You cannot afford to do this if you want to achieve financial freedom.
Having an emergency fund is important because it will help you to achieve your financial goals.
You also need to have a guide for what needs a response from your emergency fund.
For example, shopping for that 3M Louis Vuitton bag isn’t how to use your emergency funds.
You cannot always respond to every one of your financial needs with an emergency fund.
Dig deeper to identify what an emergency fund is or how it will work for you.
If you use your emergency fund well, you will reap the benefits that come with having this emergency fund.
Are you going to build an emergency fund?
Do you have an emergency fund or are you challenged to start building one?
What do you use your emergency fund for?