In this article, we will outline the basic concept of an emergency fund and explain how one can take the first steps toward its creation.
What is an Emergency Fund?
Money saved for when life’s emergencies strike—for example, a big medical bill, a car breakdown, or even unemployment—constitutes an emergency fund. It will help you avoid taking out loans or other tough financial decisions.
By definition, it should cover your financial needs for three to six months. However, this period may sometimes turn out little depending on how you spend. You should therefore have at least nine months of expenses set aside. On expenses, this should include all your monthly expenses from household bills, food, transport and credit.
However, please note that this money should only be used for unexpected and urgent situations . It should not cover other types of expenses.
Create a budget and see where you can save the most
Although it’s not going to directly affect your income, the first step—creating a family budget—is intended to reduce your expenses and maximize your savings so that later you can make maximum contributions. There are several ways to create family budgets. This can be done either by manual work or by using free apps available for this purpose.
On top of that, list down all the expenditures you made in a month. Try as much as you can to add as many items as possible that you want to include, from housing to credit, food, transport costs, and many more. Then, analyze those that are not fixed amounts and look for strategies to reduce them as much as possible.
This way, you will maximize the money you have left over each month and that you can direct to your fund. Finally, you should allocate a portion to each monthly expense. This amount corresponds to the budget for that expense. The idea behind this method is to avoid exceeding the established budget as much as possible.
Set a goal for your emergency fund
In this step, you should set a goal for your emergency fund . As mentioned, ideally these funds should cover three to six months of expenses. However, you should set a goal that you feel comfortable with. If this timeframe is too short for you, you can set a different goal, such as one year.
Small, regular contributions to the emergency fund
As with any type of savings, you should avoid setting goals that are too high, especially at the beginning. When building your emergency fund, you should focus on small, consistent contributions . Regularity is more important than amount. It’s therefore better to set a little aside every month than to set more aside every few months. Of course, in months when you are able to contribute a bit more, you should do so.
Once you have followed the previous steps, your savings should be maximized. Next, allocate this amount to your different goals.
Automate your savings
Therefore, the next step should be to automate your savings . In other words, with your automated savings, the money goes directly to a specific account, which you should not easily access.
This way, you can create an account for your emergency fund, to which you contribute a fixed amount each month from your current account. This will automate the process, reducing the possibility of spending the money in other ways. This process aims to reduce the “temptation” of spending money intended for your savings.
Save money you didn’t count on
In case you get money that you weren’t expecting for some reason, you should save it and allocate it to your savings. Try to think that you weren’t expecting this money. Therefore, your expenses didn’t depend on it. In light of this, you should allocate it to your emergency fund or divide it among the different types of savings you have.
When we refer to money that you weren’t counting on, it could be a refund from a company or service, an extra amount that you were given, or even a refund from the IRS (which is not unexpected, however, you can allocate part of it to your savings).
Avoid price increases
Once your savings are secure and automated, you need to maintain them . In this sense, you should avoid increasing your monthly expenses. Just because you have your savings secured and are building your emergency fund, it does not mean that you should introduce new expenses.
When the goal is to save and create a fund, it is important to ensure that your expenses are minimal, but without giving up quality of life in favor of savings.