What almost all experts will tell you is that before you decide upon any other saving goals, you must first be working towards building an emergency fund (sometimes known as a ‘rainy day’ fund).
What are emergency funds?
Emergency funds are predominantly a way of protecting yourself against a loss of income; which for most people will be a job loss. Of course, there may be other circumstances that will necessitate tapping into your emergency savings, such as unexpected and expensive car repairs that your usual monthly budget cannot cover.
Is an emergency fund worth having?
Living ‘paycheck to paycheck‘ is a stressful existence and if using debt is your only option for dealing with a major financial incident, then anxiety levels can begin to creep up and affect your quality of life. Nobody wants to be lying awake at night worrying if a cheque is going to bounce.
Over the past two months, we’ve had to dip into our emergency savings for major and unexpected car expenses. It’s been a pretty stressful time, and although we hadn’t quite reached our goal of what we wanted to have saved in our emergency fund, the car debacle was a hell of a lot less stressful than it would’ve been had we not had some money in the bank to pay for not only the extensive gear-box work we had done but eventually a new (used) car!
What constitutes an ’emergency’?
Generally, something is an emergency expense if it’s:
b) necessary and
So your child’s birthday wouldn’t be classed as a good reason to take from your emergency fund, as you know exactly when it’s going to occur each year!
How much do I need to have in my emergency fund?
Some finance specialists advise that you have an emergency fund equal to three to six months’ worth of your usual INCOME, whereas some recommend that you have three to six months’ worth of your usual monthly EXPENSES (or outgoings) saved.
If you’re going to use your expenses to calculate your emergency fund savings goal, then you may want to know that some professionals recommend that you include only vital expenses (so this wouldn’t include any of your usual recreational or discretionary spendings unless you’d end up with a penalty that would cost you more than what you’d save by cancelling it – such as a mobile phone contract).
You may also want to consider if, during whatever financial emergency you’re going through, you’ll want to temporarily pause saving, making additional debt repayments and any investing towards retirement.
Of course, you’ll be able to reach your savings goal of having a complete emergency fund much faster if you’re aiming for covering only vital expenses. However, for those on a low income who don’t have much left to spend on non-essentials each month, there may not be a lot of difference between six months of income and six months of expenses!
Consider having an ’emergency budget’
When we first decided what our absolutely vital minimal expenses were, we looked at our usual monthly budget and went through each category and expense and subtracted any budget item that we could easily cancel without penalty if Mr.B were to lose his job. By doing this, we developed our emergency budget and were quickly able to work out how much (or little) was required to hit our goal of six months of expenses in the bank.
If the proverbial hits the fan then we can follow that bare-bones budget.
If you hate the idea of tightening up on your spending habits during say, a job loss, you may prefer to have three to six months of expenses saved, but be aware that if you don’t reduce your spending during the period of unemployment (or going from two incomes down to one) and you still haven’t found another job at the end of those three or six months, you’ll face problems. By cutting right back, you’ll be able to make that emergency fund last as long as possible and furthermore, you’ll have less to put back into the emergency fund once the storm has passed.
Do you have an emergency fund? If so, how long did it take to save? How many months of income or expenses did you decide upon and why?
If you don’t have an emergency fund, is it something you’d like to achieve? If not, how will you deal with large and unexpected expenses or a loss of income? I’d love to hear from you!
For more on saving, check out: ‘Are You Within the Recommended Guidelines for Your Monthly Expenses?‘