The importance of an emergency fund
What is an emergency fund, how much should you have in them, and when is it acceptable to dip into it?
We’re going to explore all this in more detail. Please consider, although some figures may be suggested in this blog, your emergency fund savings should be calculated with your personal circumstances in mind. We’re here to help if you have any questions.
What is an emergency fund?
Simply put, it’s money that you keep tucked away ready to be used if something happens out of the ordinary. This doesn’t mean you need it tucked away in cash ready to grab and run, but it most definitely should not be tied into a long term saving strategy, property or investments.
Your emergency fund needs to be accessible and easy to dip into at moments notice, when you need it most.
Why do I need an emergency fund?
It gives you peace of mind to know an emergency fund is there for any expenses that you may not be expecting. This could be anything from a car accident to an emergency vet bill. Although it also ensures you are covered if you ever found yourself unexpectedly unemployed. If this year has taught us anything, it’s to prepare for the unexpected.
We cannot predict the future, which is why we always need to be one step ahead and prepare for the worst. Your emergency fund is there to help when you need it the most.
How much should be in your emergency fund?
There is no rule or set value. Although it is good practice to cover three to six months wages. You may instead choose to save enough to cover your bills for three to six months instead. To work this out calculates how much you spend each month on your mortgage or rent, bills, food, child care, and transport. Try not to include anything that’s non-essential in these calculations. You only need to cover essentials in an emergency.
So, for example, if your monthly expenses came to €3,000 – including mortgage, food bills, utilities, insurance, and other necessities – then your emergency fund should aim to be at least €9,000 to cover three months or as much as €18,000 if you wish to cover six months.
Although, if those figures seem scary, and you’re nowhere near having those figures tucked away. Fear not, because even a few hundred euros in your emergency fund could help you out of a financial crisis.
When to use your emergency fund?
Having an emergency fund is a terrific start. Although sometimes when an emergency occurs, we face the dilemma whether to dip into the fund or not. If the time comes to use it and you don’t, then it hasn’t fulfilled its purpose.
There are many good reasons to use your emergency fund, typically they’ll be unexpected and immediate costs. We listed a few examples above, but these are by no means an extensive list. Everyone’s emergency fund is personal to them, and every individual has different financial emergencies.
We suggest using your emergency fund to cover any unexpected expenses you face. This fund could be used to prevent you having to take on any debt. Although it is always a good idea to apply common sense before dipping into your emergency fund by asking yourself these questions:
- Is it necessary?
- Is it urgent?
- Is it unexpected?
Where should you keep your emergency fund?
We suggest keeping your emergency fund in an easy-to-access savings account. Ideally, one which offers a competitive interest rate. By doing this, your money still has the opportunity to earn interest, but you will still be able to withdraw the cash quickly in an emergency, should you need to.
This account could be a simple cash savings or even a separate current account. The main thing is the money is kept somewhere different to your everyday spending account – for example, your daily use current account – as this makes the emergency fund tiresome to keep track of and is way more tempting to dip into.
How do I build my emergency fund?
If you don’t yet have an emergency fund and want to start building one, then you’re on the right track. This is the process we recommend:
Plan
Firstly figure out how much you want to have in your emergency fund by calculating your expenses, then decide if you are leaning more towards having three or six months saved. An idea is to foresee three months as your first goal. Then you can continue saving to your six month goal from there.
Save
Small and achievable short term goals are a wonderful way to start saving. Try saving 10% of your monthly income if you can. Even starting with €100 will allow you to gradually grow your emergency fund. The worst thing you can do is commit too much. It can make saving feel way tougher than it needs to be. Another option is to automate a regular monthly amount to leave your account on pay day. This way, you’re not tempted to spend the money or have to remember to manually transfer it.
Monitor
Even if you do choose the automated route, it’s still a good idea to check in on your savings. This is where you could think about adjusting how much you put in to align with your goal and factor in other life events. Once you’ve achieved your goal, you may want to look at putting any excess savings elsewhere, or whether you want to keep building on your pot. Also, remember if you do dip into your emergency fund, you need to top it back up!
When to stop saving into an emergency fund?
This question is tough, as there is no right or wrong answer, and you could keep saving and saving. Although we do recommend putting a cap on your emergency fund and separate all other savings for things like holidays, house deposit, retirement etc. With these longer term saving plans, you are unlikely to need access to the money instantly. Therefore, you are best off-putting these ‘other’ savings into accounts with higher interest rates, locking your money into a long-term account. Our advisors can also give you further advice on how you could invest these separate pots of money, which you could allow to grow over a longer period.
Why shouldn’t you invest your emergency fund?
You will remember one of our first points was to stress how an emergency fund needs to be quickly accessible. When it comes to investing, you have to sell everything you hold to take your money from the investment scheme. This may mean you will not be able to access the money as quickly as you need for emergencies.
Also, you have market fluctuations to overcome. Those same fluctuations that allow your money to grow, can also mean you lose money if you do not sell at the right time. In a current account, if you’ve saved €1,000, then you know you can easily withdraw this amount. But with investing, your €1,000 could be worth that today, but fall to €900 the next.
This change in value could make paying for your emergency harder if you end up losing some of your hard-earned money. Remember, investing is not a short term solution or something you can keep dipping into. It’s a lengthy strategy, and our advice is not to invest your emergency fund. It needs to be there ready to dip into when you need it most.
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Lawsons Equity – Financial Advisors Malta
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