- Setbacks happen, be prepared
- Automatic transfer directly to your savings account in order to build the emergency fund
- Money in an emergency fund should be easy and quick to access
- Emergency fund provide peace of mind and a buffer zone to debt
Setbacks happen in life; car breaks down, need an emergency procedure, or have to take an unscheduled trip. We need to be prepared for these so that we don’t have to sell investments or go into debt.
Ideally, we want to set up savings on a monthly basis which will build up our emergency fund. The consistent savings can be transferred into either an investment account or savings account. I have set up a standing order with my bank that will automatically transfer from my current account into my savings account; this is triggered at the beginning of each month. See the consistent savings topic for more information on paying yourself first. I will maintain this savings rate until I have enough money in the fund that will cover my expenses for at least three months.
An emergency fund should be easy to access but preferably making some interest; a savings account is ideal for this. You probably won’t be able to make much interest from the savings account though. However, it is more important to have quick access to the funds than having to decide which investment to sell or worse still, where you can get a loan to pay for the setback.
I believe that the emergency fund growth should come prior to paying off any major debt. My reasoning behind this is that if you are paying off debt, let’s say, a large credit card loan, and something happens that will set you back financially, you will find yourself using the credit card to pay for that emergency. This will set you back again and dishearten your progress. At this point, it may start to seem useless, that you are not getting anywhere, and it would be easy to give up. However, having an emergency fund in place, you could use those funds to tackle the issue. Then once the emergency fund is replenished again you can start tackling the credit card debt again.
There is a debate whether the emergency fund should cover three months or six months of expenses. I believe this is a personal preference. I prefer three months as I would rather have the extra three month’s savings working for me in an investment account.
Of course, you need to be tracking your expenses so that you know how much money you will need in order to cover your expenses each month. Your emergency fund should cover at least three months of those expenses. This will give you enough time to sort out what you need to do in order to get income coming into your account again.
Your emergency fund will give you peace of mind so that no matter what life throws at you, you will not have to panic. You will not have to go into debt and you will not have to start selling off your investments.
If your car breaks down and it will cost you €500 to get it fixed, that should just be a setback and not get you into debt. Having cash on hand to pay for these setbacks gives you a buffer zone between a small setback and further debt. Having that emergency fund is the difference between a situation being “Oh crap!!” to just “ok, let’s get this fixed”
If you have three to six months of expenses in cash and you are let go from you job, it should not be panic stations for you. Wouldn’t it be nice to know that you can easily coast for the next few months while you look for the job you want. If you don’t have that emergency fund then you may have to take the next available job even if it is one that you don’t want.
As you can see, I am a true believer in emergency funds. It takes some of the stress out of life and it gives you security that you can handle almost any financial situation that is thrown at you.