What Is an Emergency Fund and Why Do You Need One
Imagine this; you are traveling on a public bus with your fancy laptop, and at the park, you put your bag on the floor cus on the weight but before you can say “cheese” a driver already shove your bag under a seat. Now you ask him to bring it out but unfortunately, the screen has already cracked. You pull it out to inspect the damage and find that you need a new screen or probably a new PC, but you don’t have the funds to cover the cost.
Where/Who do you turn to?
This scenario is all too common, and it highlights the importance of having an emergency fund. This was my story some weeks ago though I was intending to get a new one.
What is an Emergency Fund?
A saving account with a lump sum of money set aside for emergencies(events/occurrences that are not planned for but has financial implications), with the sole purpose of helping individuals cover the unexpected cost without having to rely on high-interest credit cards or loans.
This fund can be used for things like unexpected car repairs, medical bills, or job loss. Emergency funds are typically kept in a separate account from your regular savings account or checking account. An emergency fund could be kept in cash or in highly liquid assets.
Understanding Why You Need an Emergency Fund
It might sound so logical to have a lump sum of money laying somewhere but when you think about what the recent crisis(Covid, tech layoffs, financial crisis, etc) has taught us, it’s that at any time there can be a reason to rely on a source of cash that different from your primary income.
So it starts to make sense when you ask questions like; where will this source of cash come from? If you’re in the undeveloped part of the world, the last thing you would expect is a lump of cash from your government. Hence the need for an emergency fund, which can only be provided by you, for you!
There are many reasons why you need an emergency fund. Here are a few of the most important ones to convince you:
- Unexpected Expenses: Life is full of surprises, and unexpected expenses can come up at any time, I mean no one knew covid was coming and could you have predicted tech layoffs when VC funding was rising to an all-time high(even in Africa)? Having an emergency fund can help you cover these expenses without derailing your financial goals.
- Job Loss: Losing your job can be a devastating blow to your finances. An emergency fund can help you cover your expenses while you search for a new job, plus it gives you the calmness not to lose your shit when you’re hit by the wind of layoff.
- Peace of Mind: Maybe it’s just me but I do sleep better when I’ve got basic expenses covered. Knowing that you have a safety net can help you sleep better at night. With an emergency fund, you will be better prepared for whatever life throws your way.
- To Protect Your Investment: If you take out of your investment at every slightest emergency, you will deprive your portfolio of attaining optimum growth and might even experience loss in cases where you have to sell your asset at lower prices.
How Much Should You Have in Your Emergency Fund?
The amount you should have in your emergency fund depends on your individual circumstances. A good rule of thumb is to have a minimum of three months’ worth of living expenses in the emergency fund. This will help you cover your expenses if you lose your job or face unexpected health expenses.
Where Should You Keep Your Emergency Fund?
When establishing an emergency fund, I will say it is advisable to set up a separate account solely for this purpose to keep your emergency fund in a separate account from your regular savings or checking account. This will help you avoid the temptation to dip into your emergency fund for non-emergency expenses. Emergency funds could be kept in cash or in highly liquid assets.
How Can I Create An Emergency Fund If I am Living Paycheck To Paycheck?
If you find yourself in this situation, your primary task is to consistently set aside a certain percentage of your paycheck to fund your emergency account. It won’t be easy, but instead of worrying about your eventual savings amount, decide on a percentage of take-home pay that you can do without. It can be 1% or 2%. The important thing is to save a set amount each payday and not touch it. The money will add up.
What Is An Emergency Fund Not For?
Let’s set the record straight dear friend, an emergency fund is to cater for high priority and unavoidable expenses not for an unexpected bill that you can’t pay — no money to go to a movie or sometimes you overspend while with friends at the restaurant. It is important to make sure that you can distinguish between what is an emergency and what isn’t.
How to Build an Emergency Fund
Just like investing starting early is the best way to go but first, we need to establish a destination so we jump on a train heading nowhere. Previously we discussed how much you need to keep in your emergency fund, I suggest you hold on and calculate that figure before you continue as this will be your true north on this journey.
Now that you’re back it’s noteworthy to say that; building an emergency fund takes time and dedication.
Here is how to build yours;
- Set a Goal: you have taken the first step by determining how much you need to save for your emergency fund. The next step is to set a savings goal and determine what percentage of your income you’ll set aside until you achieve the figure you calculated. Make a plan to reach that goal over time.
- Cut Expenses: Look for ways to cut your expenses, such as eating out less or canceling unnecessary subscriptions. Use the money you save to fund your emergency fund.
- Automate Savings: Set up automatic transfers from your checking account to your emergency fund to make saving easier.
When Should You Use Your Emergency Fund?
Your emergency fund should only be used for unexpected expenses or emergencies. It is not a source of funding for non-essential purchases. If you do use your emergency fund, make a plan to replenish it as soon as possible.
An emergency fund is an essential part of your financial plan. It can help you weather unexpected events and give you peace of mind. By following the tips outlined in this article, you can start building your emergency fund today.
I hope this helps you become better and more secure financially
With Love 💰💗
Olufemi CA
