An emergency fund prepares you for life’s uncertainties. It is a foundation of good personal finance. Want to know why you need it and where to invest your emergency fund? Here are the scenarios when it becomes useful:
If there’s one thing the global pandemic has made very clear, it’s that nothing in life is certain. Whatever you have today can be taken away from you tomorrow, whether it’s your job, your house, your health, or your savings. Having an emergency fund played a big role in the current pandemic. But what is it and how do you save for it?
What is an emergency fund?
An emergency fund can save your life if something bad happens. Also called a cash cushion, an emergency fund is money saved for the unexpected.
An emergency fund isn’t money you use when you want to buy a big-ticket item or travel out of town on a whim. Emergency funds must be reserved for moments like an unexpected hospitalization (especially with COVID-19), losing your job, or your car breaking down and needing major repairs.
How much should be saved in an emergency fund?
There is no fixed amount for an emergency fund. It depends on your living expenses. But as a general rule, emergency funds should cover at least three to six months’ worth of your living expenses. The idea is that your emergency fund should be able to cover your daily expenses for at least half a year should anything that hinders your ability to earn happen. Some people only factor in only the bare necessities when computing for their emergency fund (i.e., food and utilities) while others choose to add in a few luxuries to help them maintain the lifestyle they are accustomed to. Adding a window for luxuries may come in handy in the future since it’s a form of overpreparation. But then again, it depends on how much you make and how much you can save.
When building your emergency fund, just keep asking yourself: Is this enough to tide me over in case anything happens to me or my family?
Where to invest my emergency fund?
As to where you should keep it, keep in mind that an emergency fund should be highly liquid, so you should be able to have access to it at a moment’s notice. Investing it in things such as Variable Unit-linked Insurances (VULs), Unit Investment Trust Fundds (UITFs), and stocks are not recommended.
Good emergency fund options are high yield savings accounts which are separate from your current savings account or kept physically at home in a secure place like a safe. The best way to keep your emergency fund is to put it in a bank so that it’s accessible when needed, but not too accessible to prevent impulsive purchases, and it can still earn interest.
What counts as an emergency?
There are numerous ways you can use an emergency fund, and numerous ways you can abuse it. This is why it’s important to establish what is and what isn’t a financial emergency.
A financial emergency is an unexpected major expense that requires you to use money immediately. These include:
What isn’t an emergency:
How to build an emergency fund
Having an emergency fund helps you through those rainy days and gives you peace of mind knowing that you can weather any storm that comes. Here are steps to building your emergency fund.
Make a budget
As with anything, start by making a budget. This helps you manage your money better and find places you can cut back on your spending. Begin by listing down your monthly income and all of your monthly expenses. Make it as detailed as possible. Then, categorize your expenses according to needs and wants. Establish how much you can spend per category and once you’ve decided on a number, lock that in. Commit to it and see it through every month.
Set a monthly savings goal
This is the monetary amount you want to work towards each month and commit to adding to your emergency fund. If you’re a single income family or if you’re earning just enough at the moment, it can be difficult taking a part of your salary each month and locking it away. This is why budgeting is key. A big amount each month can be difficult but smaller amounts are possible. Just keep working at it and being consistent. You’ll get there before you know it.
A lot can change in a few months’ time. You could land a coveted promotion, pick up freelance work, find you’re spending less than what you budgeted for, etc. Make it a point to review your budget every so often and see what is and what isn’t working for you. If there are ways for you to save up more so you can reach your emergency fund goal sooner, do it!
Should I invest my emergency fund?
This is tricky. Investing can have gains which are bigger than leaving your money in a secure savings account. But with the potential for bigger gains comes the risk of bigger losses. Remember, there is always risk involved when it comes to investing, no matter how small. Given today’s volatile stock market, investing something as important as your emergency fund isn’t recommended.
You don’t want to risk losing your lifeline and your last line of defense. You’re better off securing it in a savings account, even if it means it does not grow very much.
Why is an emergency fund important, and why should it come before investing? Here are several scenarios:
Loss of employment
Losing a job can happen to anyone for various reasons, including company restructuring or downsizing. This was made very clear by the global pandemic. Even the most secure job positions and companies were forced to close shop because of difficulties brought about by COVID-19. An emergency fund allows you to survive until you find your next employer.
Getting sick or meeting an accident
Nobody likes to think about getting sick or going through a major accident but recovering from illness and injury entails medical costs. Without an emergency fund, you are forced to spend money that normally pays for your living expenses. This causes added stress and may lead to anxiety. Instead of focusing on your recovery, you’re more worried about figuring out how you can afford your medical bills. If you do get to pay them off, you may find yourself in debt for years to come.
Having a child
A pregnancy comes with prenatal care expenses, as well as long-term changes to your lifestyle. If you have not previously saved up for your little bundle of joy, he or she can eat away at your savings. This is where an emergency fund comes in handy. Having a baby in the Philippines can cost up to PHP 2 million. An emergency fund gives you a bit of a cushion while you save up for when your baby arrives.
Investing in insurance
Another option is to augment your emergency fund by investing in health insurance. Insurance companies provide protection in the form of a big payout to you or your family, if something bad were to happen to you. This payout covers expenses for things such as hospitalization, doctor’s fees, medications, treatments, testing, and even an allowance for loss of income.
However, unlike an emergency fund that you can use anytime you need it, insurance has certain conditions where certain emergencies are not covered. You also cannot “withdraw” it as you may from your savings account.
And unlike an emergency fund, health insurance can only protect you from medical-related incidents. For instances such as when you lose your job, your car breaking down, or your house needing sudden repairs, your health insurance won’t be able to provide you with any financial assistance.
If you plan to invest in the future, it is important that you first build an emergency fund. Without one, you’ll have to cash in your investments to pay for the unforeseen cost of an emergency.
This article is part of a collection of stories and practical financial tips that are published with the goal to help people learn from the experiences of others, and to pick out lessons on personal finance and sound money habits beyond the pandemic.