Having an emergency fund in place that you can use to pay unexpected bills or cover your living costs in the event of a job loss or illness is one of the key measures of your financial wellbeing. However, building that emergency fund can be easier said than done.
As a rule of thumb, you should aim to build an emergency fund that will cover your total living expenses for between three and six months. However, any amount that you can put aside that can prevent you from going into debt when unexpected expenses occur, such as a car or home repairs, will be invaluable.
In this article, we’ll take a look at four simple steps you should take to build an emergency fund and introduce a few resources that will help you along the way.
Determine your needs
The first step, as set out in the ‘financial readiness pack’ published by wonga.co.za, is working out how much money you’re likely to need. To do this, you need to think about the type of financial emergency you’re saving for. If it’s an unexpected expense such as a car, appliance, or home repair, you’re looking at a potential cost that, although expensive, will be fixed.
The second type of emergency you can save for is a loss of income through an unexpected bout of unemployment or ill-health. If you’re saving for this type of emergency, you should consider how stable your job is and how easy it would be to find another one. If you work in an in-demand profession, then any period of unemployment should be short. If your opportunities are more limited, then your fund may need to cover your costs for six months or more. You can download a full PDF copy of the readiness pack here.
Based on the amount you’ve decided you’ll need, it’s worth thinking about how long it will take to reach your target. For many people, creating an emergency fund is a long-term financial goal, so don’t expect it to happen overnight.
The most effective way to start saving is to calculate how much you can afford to save every month and set up a standing order that moves money into a separate savings account as soon as you are paid. That way, you won’t have the opportunity to spend it. If you have extra money left over at the end of the month, add that to your savings, too.
Choose where to keep your emergency fund
Your emergency fund should be liquid, meaning that you can get your hands on the money quickly in case of an emergency. However, it’s also beneficial if your money attracts a decent rate of interest and starts to grow.
The interest rates being offered on savings accounts are extremely low at the moment, so perhaps you could invest the money in a low-risk managed fund, guidance on this can be found courtesy of Lovemoney.com A fund manager will invest your money across a range of assets such as government bonds, property and company shares. Although it will typically take a couple of days to withdraw your money, you’ll usually get better returns than you’ll receive from a savings account, although there is the risk that the value of your emergency fund could fall.
Decide when to use your emergency fund
Once you’ve put in the time and the effort to build an emergency fund, it’s important to be extremely selective about when you use it. The last thing you want is to spend it unnecessarily and be back to square one. When deciding whether to use your emergency fund, ask yourself three questions:
- Is it unexpected?
- Is it necessary?
- If it wasn’t for my emergency fund, would I need to go into debt to pay it?
If the answer to all three of these questions is yes, then using your emergency fund is probably justified.
Have you successfully built an emergency fund? What have you used it for? Please share your tips with our readers in the comments below.