Emergency Fund: What is it for and how to build one

A lot of factors happening every day can be a cause of financial distress. We never know what kind of unforeseen events might happen to you next. Because of this, it is essential to provide yourself with a financial safety net. Building an emergency fund can help you meet unanticipated expenses.

What is an Emergency Fund?

An Emergency Fund is defined as money being put aside that can be used in future times of financial problems. These issues include medical expenses, property damage, family emergencies, and unemployment.

This can either be in cash or other highly liquid assets. In addition, having an emergency fund can make you avoid diving into high-interest debt options like credit cards, unsecured loans, and even drawing from retirement funds.

How important is it?

The saved-up money for your emergency fund is the collection you can fall back on at times of financial crisis and unplanned situations. It is a vital bulk wherein its use is to deal with emergencies. Also, it is one way of protecting your savings. Having this money aside will help keep your savings untouched even in the face of financial problems.

How to build an emergency fund

It is important to build one as soon as possible to harvest its benefits when needed.

Know the total amount you want to save- Calculate your daily expenses within a desired period. Then, with the total money left from your expenditures, calculate an attainable target, which will be your emergency fund. You can start by having a monthly goal. Usually, the more achievable your target is, the more you will be encouraged to save money.

Consistently move money into your savings account- There will be times wherein you will receive excess money such as gifts, income from hobbies, interest, bonuses, and tax returns. Remember to continually contribute to your emergency fund by putting aside unspent money. You can make this process easier by working with a financial institution to set up automatic transfers into your savings account.

Save your tax refund- If you expect a refund in a year, it is an excellent opportunity to add money to your emergency collection. Consider moving this money into your account directly to save it for emergencies. This way, you can reduce the temptations of spending it for discretionary purposes.

Study and adjust savings- After a few months, check on how much you have saved for your emergency fund. After assessing, increase or decrease the monthly amount you set aside as needed. If the time comes when your emergency fund is enough to cover several months of expenses, consider putting your extra cash into some reliable investments.

The best total amount for an emergency fund

The most suitable amount may be based on your current financial situation, daily expenses, lifestyle, and debts. However, it is recommended by many financial advisors that your stash must be enough to cover at least three to six months’ worth of expenses.

A celebrity finance guru suggested having an emergency fund that can deal with eight months’ worth of expenses to be more financially comfortable. The guru also pointed out how sudden it is nowadays for economic slumps to happen.

To calculate the best size of savings for you, estimate the amount you make in a month. If your situation involves living paycheck to paycheck, determine the total you can live without spending. It can just be a small amount. What’s important is you have something to contribute to your emergency fund. No matter how small your contribution is, eventually, it will add up.

Differentiating emergency funds and discretionary expenses

Nowadays, it is a challenge to differentiate between essential and nonessential spending. This is due to specific trends and needs that are being mixed up. People, especially young adults, need help separating what they want from what they actually need.

An emergency fund is an essential collection that is being saved to be used in times of need. The key here is the word “need”. This type of money is spent on things and factors that are hard to live without or difficult to deal with without fixing.

Meanwhile, discretionary expenses refer to spending on what you want but don’t need. These take on many forms, such as going to restaurants to eat, buying new clothes, purchasing gifts, upgrading your phone or electronic appliances, jewelry, etc. Again, these are things you spend on but are not necessarily mandatory.

To know what is essential, try to start with analyzing a small purchase. Then, determine whether or not you can survive without having it.

Where should you put your emergency fund?

Since an emergency could happen at any time, you must have it easily accessed and easily liquidated. Also, it is ideal to put this type of money into a savings account with a high-interest rate. However, to avoid being tempted into spending it, the account should be separate from the bank account you use daily.

A good suggestion for your money is to put it in a high-yield, federally insured-savings account. Your account should be insured by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA). By doing this, the money could earn interest, and it is easily accessed.

Wise financial thinking

It is essential to separate what you need from what you want. Be aware of how you spend and how much you spend. If a particular purchase is unnecessary, you can resist adding it to your expenses. Avoiding discretionary or nonessential expenses can get you closer to your financial goals. Manage your money in a way that is suitable to your lifestyle. It helps if you plan or ready yourself for emergencies or unexpected events. That way, you could add more to your emergency funds. Another thing to analyze is if you are spending more than what you are earning. To avoid this, learn how to prioritize financially. Once you find your correct flow in saving and spending wisely, work on it consistently. Consistency is one of the keys to making your emergency fund bigger.

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