How to Create an Emergency Fund – Simple Guide!
One of the best pieces of advice we received before we started our debt free journey was to build an emergency fund.
When I first committed to paying down my debt, I was overwhelmed and didn’t know where to start. It was a lot of debt and it seemed like our budget would never allow for me to make even the smallest dent in it.
But time and time again I read about the importance of having an emergency fund.
And I’m so glad that this was the first step I took.
It seems counter intuitive to save money when you want to pay off debt. But trust me (and countless personal finance experts) when I say it is crucial to your success.
There were several times while I was focused on paying off debt, that I would have been side-tracked if I didn’t have an emergency fund.
For example, there were emergencies including a plumber for a leak, washing machine repair and other costs that add up.
These were all funded from the emergency fund, allowing me to continue to make progress towards paying down my debt.
I never had to take on additional debt to cover these expenses, nor did we come up short at the end of the month because of these expenses.
The emergency fund was a great tool to rely on when paying down debt and staying debt free.
Lets break down how to create an emergency fund!
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What is an emergency fund?
An emergency fund is an easily-accessible pool of money that you keep for life’s emergencies.
Common emergencies that have financial impacts are:
- Losing a job or needing to quit a job
- Car repairs
- Unexpected home repairs or home loss
- Dog visit to the vets
The idea is that you set aside an amount of money so that if an emergency occurs, you have the cash to pay for the emergency.
If you don’t have the money for an emergency you might have to pay for the emergency using debt (like a credit card) or pull money out of retirement savings.
Each emergency can range in cost.
So, if you lose your job and you expect it would take you 6 months to find a job, you may want a fund that would cover 6 months of expenses.
This compares to lower-cost emergencies like repairing your house or car.
Essentially, the fund serves as a buffer so that if an emergency happens, you do not face additional hardship.
Why do I need an emergency fund?
Life is unpredictable and unexpected events can catch us by surprise, your car has unexpected repairs needed on your car, the washing machine stops working, or you lose your job!
Without money set aside to cover emergency costs, you could be forced to pay bills with a credit card, loan, or line of credit.
All these options can easily end up costing you more than the initial bill because of high interest payments.
Choosing high-interest loans can leave you in a hole you can’t get out of! You’ll have to pay them back right away to avoid interest charges and making the required payments may leave you short – resulting in the need to borrow money.
This creates a cycle which can drown a family in debt.
Building an emergency fund for yourself makes it possible to:
- pay for an unexpected expense without going into debt
- avoid high-cost loans and cash advances
- have financial control and peace of mind
Want know how to create a budget, but don’t know where to start? Then see the post below:
How much should I have in my emergency fund?
I think a better question is:
How much helps you sleep better at night?
Everyone has a different answer to this question. Depending on your life circumstances, this answer may vary.
But what do the experts say?
Many financial gurus recommend saving £1,000/$1000 in your emergency fund before tackling your debt, then raising that amount to 3-6 months of expenses after your debt is paid off.
Some say you need as much as 8 months of expenses set aside.
I think £1,000 is far too little to deal with a real emergency. But I also don’t think you need 6 months of savings sitting there, untouched, until later.
Personally, I recommend having 2-Month of expenses set aside in your Emergency Fund.
This amount serves 2 purposes:
- It gives you a few thousand pounds/dollars to deal with larger emergencies (car repairs, house repairs, vet bills)
- It gives you the ability to have ALL your money for the next 2 months saved up BEFORE the month begins.
The goal is to be able to absorb the cost of life’s fun little “financial detours”, without affecting your monthly budget, or your goals.
Having 2 months of expenses is hardly enough if something serious occurs. For example: Job loss, or something similar.
I believe you should save 2 months of expenses, and then pay off debt, before building a larger emergency fund.
Once you are debt free, I recommend saving (up to) 12 months of expenses in your Emergency Fund
Again, the exact amount here is a general guideline, but the real answer is what makes YOU feel comfortable.
For some, 3 months is just fine, for others, they NEED 12 months to enjoy life.
Whatever that number is, just make sure it suits you and gives you that peace of mind to fall back on.
Want some ideas on how to cut your monthly expenses? Then see the post below:
Develop emergency fund goal
Once you have identified how much you want to be in your emergency fund, you need to set you goals to achieve.
With specific goals and objectives for your emergency fund, you will be much more excited and motivated to save money and develop an emergency fund.
They also make sure that you are making progress in terms of creating a fund. For instance, you can create the following goals:
- Goal 1: Save 1-month living expenses by July.
- Goal 2: Save 2-month living expenses by September.
- Goal 3: Save 6-month living expenses by February 2021.
Such goals should be written and kept insight to ensure you are making progress to achieve them.
Typically, people choose to put their different types of goals, including emergency saving goals, on their fridges.
Similarly, many new smart devices applications allow people to write their aims, set reminders, and track progress towards these goals.
Want to learn more and setting SMART financial goals? Then see the post below:
Open a savings account
I don’t recommend putting your emergency fund in your current account or a savings account linked to your current account. You want to be able to easily access the money in case of an emergency but not such that you are able to withdraw or transfer money at any time.
I recommend opening an online savings account because:
- It is free to open a savings account
- There may be a bonus for opening a new account
- There are no fees
- You can transfer money easily
- It takes 2-3 business days to transfer money into your regular account
If you don’t want to open an online savings account, try another bank or a credit union. Look for:
- A savings account at a different institution than your checking account.
- There are no fees
- No minimum balance required
- Compare interest rates
From experience, I would not recommend having an emergency fund account tied to your current account. It is easy to access that money with your debit card. My emergency fund savings account is at a different bank, plus I declined to have an ATM card. To withdraw money from this bank, it is too much hassle for me.
How to start an emergency fund with no money?
If you are the person who gets to the end of their month with pennies leftover, I hear you!
But the honest truth is you are the type of families who need these accounts the most.
So, let’s talk about ways to save or make money to start supplementing your emergency fund.
To find out how to save money BIG immediately, see the below posts:
Don’t worry, there is more in there than cut out Starbucks– I know you probably have already thought of that on your own!
I promise, there is something in there that can save you money.
If you have mastered being frugal and there isn’t one more penny to cut from your budget, let’s consider making a little money on the side.
Want to earn some extra money straight away with a side-hustle? Then see the posts below:
How to create an emergency fund – Final thoughts
The unemployment rate has reached an alarming rate. People who have emergency funds will be able to manage things, depending on the size of their emergency fund.
Hence, creating an emergency fund is essential and vital.
An emergency fund should not be taken as an option. In the time of financial distress, one can take the shade of the emergency fund.
In a nutshell, make a clear plan for your emergency savings. It would provide you comfort and solace at one point in time.
Do you have an emergency fund? How much do you have saved? Let me know in the comment section.
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Welcome to my blog! I’m a money-enthusiast, who enjoys helping like-minded people make money, save money and manage their finances. I have also created a lifestyle section, where I will be sharing what has helped me in my journey towards a happy life after 4 years of battling severe anxiety, depression and alcoholism.