Here's how to create an emergency fund and determine the right amount to save for unexpected expenses in order to achieve financial security.
Life is full of surprises, both good and bad. While it's easy to get excited about the good stuff, the bad stuff can really knock us off our feet – especially when it comes to our finances.
That's where an emergency fund comes in handy.
What is an emergency fund?
An emergency cash fund is crucial for your financial stability and peace of mind. Think of it as your own personal safety net that can keep you financially secure when things get tough.
Here are some examples in which an emergency fund will come in handy:
- Loss of a job
- Medical expenses
- Home and car repairs
Imagine having to pay a huge medical bill without any savings – that's a stressful situation that can take years to recover from. But with an emergency fund, you can breathe easy knowing that you've got the money you need to cover unexpected expenses.
Instead of relying on credit cards or loans which can lead to more debt, you can use your emergency fund to cover unexpected costs.
How much emergency cash do you need?
The amount you need for your emergency fund depends on your situation and goals. But a good rule of thumb is to have at least six months' worth of living expenses saved up.
First, determine your monthly expenses - rent, utilities, groceries, transportation, insurance, and other bills. Then multiply that by the number of months you want to cover. This will give you an idea of how much to save for your emergency fund.
For example, if your monthly living expenses are $2,500 with expenses in the table below. If you want to save an emergency fund that could cover six months of living expenses, you should aim to save $15,000 ($2,500*6 months) for your emergency fund.
|Electricity and utilities||$100|
|Healthcare (including insurance)||$400|
When does saving more emergency cash make sense?
Having six months of expenses saved up is a great starting point for an emergency fund, but it may not be enough for everyone. The amount you need to save depends on your individual circumstances and financial goals.
Here are some scenarios where you may need more than 6 months of expenses:
- During economic instability, such as a recession, it may take longer to find a job
- If you work in a high-risk industry with frequent layoffs
- If you're a self-employed business owner or freelancer with an irregular income
- If you're the sole breadwinner with many dependents
Remember, your expenses may increase with inflation, so regularly review your expenses and adjust your savings goals accordingly.
How to build an emergency fund
Don't worry if you don't have that much saved up yet. Everyone has to start somewhere. Start small and work your way up.
Here are some tips to help you get started:
#1 - Set a savings goal
Start by setting a specific target for how much you want to save and when you want to achieve it. Having a clear goal will keep you motivated and on track.
A good starting point is to aim for 6 months' worth of living expenses and you can increase it from there if you need it. Remember, this is just a starting point and may differ for each individual.
#2 - Create a budget
A popular budgeting guideline that you can follow is the 50-30-20 rule.
It involves dividing your income into three categories:
- 50% for essential needs
- 30% for non-essential wants
- 20% for savings.
By following this rule, you can be sure that you are setting aside at least 20% of your income towards savings, including emergency cash.
#3 - Automate your savings
One of the easiest ways to build an emergency fund is to automate your savings.
You can easily set up an automatic transfer from your checking account to your emergency fund each month. This way, you don't have to remember to save, and you'll be making progress toward building your emergency fund without even having to worry about it.
#4 - Increase your income
There is only so much we can do to reduce expenses. In these cases, increasing your income can be a great way to speed up the process of building your emergency fund.
You can start by exploring different ways to earn extra money like taking up a side hustle or part-time job. This additional income can be directly allocated toward your emergency fund, allowing you to save more quickly.
Additionally, you can consider negotiating a raise or promotion at your current job or explore another job with a higher paying salary.
What would Beansprout do?
Remember, building an emergency fund takes time. So, don't get discouraged if you're not able to save as much as you would like right away.
The key is to start small and stay consistent with your savings plan.
By creating a reliable emergency fund, you'll be ready to face any unexpected financial challenges with greater confidence and ease.
When it comes to emergency funds, accessibility and safety are crucial.
You want to be able to access your money quickly in case of an emergency, but you also want to make sure it's safe and earning some interest.
Next, we will find out which are the high yield savings account to park our emergency cash.
We’re on a mission to help you improve your financial wellness. Beansprout believes that with the right tools and knowledge, everyone can be an investor. And a really smart one at that!