Why do you need an Emergency Fund?

October 29, 2009 by Tyrone
Filed under: Personal Finance

WHAT IS AN EMERGENCY FUND?

Life has a lot of uncertainties. You may not know that one day you’ve been hit by a calamity, you had an accident, you suddenly became ill, or your house got burned.

In these circumstances, you need to be prepared. In personal finance, it is often called “saving for the rainy days”. These savings is often called emergency fund that is often used when we encounter emergency situations.

WHERE SHOULD YOU PUT YOUR EMERGENCY FUND?

Since emergency funds are savings that should be used anytime you encounter an emergency situation, you should put it in a type of investment that is liquid, safe, and don’t have long holding period. We say that an investment is “more liquid” if it’s easily converted into cash. What are these types of investments?

ATM Savings Account - You can put your emergency fund by opening a regular savings account in a bank that is accessible through ATM. Choose the bank with the most number of branches so that you can almost anytime access your emergency fund when the need arises.

Passbook Savings Account - Alternatively, you can also use a passbook savings account to lessen the temptation to withdraw your funds just anytime you want since withdrawing from a passbook account is not as convenient as compared to an ATM account. You might want to open a passbook account with a bank that is nearer to your place and provides the highest interest.

Time deposits - If you are looking for a type of investment that can provide higher interests for your emergency fund, then you might as well consider time deposits. Just remember the holding period. You should consider the time deposit with the least holding period.

HOW DO YOU BUILD AN EMERGENCY FUND?

Pay yourself first: The easiest way to build an emergency fund is to pay yourself first. If you are employed, which I believe most of us are, set aside a portion of your salary every time you receive it. Depending on your expenses, the least amount advisable is 20% but of course, the higher the better.

One of the most useful personal finance equation is: INCOME - SAVINGS = EXPENSES. That is, set aside a portion of your salary as savings before you can spend the rest. Why? It is because savings is the most important expense as it buys your own future.

Budget. Learn to budget your money. Prioritize your expenses more on the needs and not on the wants. There are a lot of ways on how to squeeze your money into savings to build up your emergency fund.

HOW MUCH SHOULD YOU SAVE FOR AN EMERGENCY FUND?

The amount you need to save for an emergency fund depends on your situation. If you are the sole breadwinner of your family, it is advisable that you need to save at least 6 months to 1 year worth of living expenses. Compute you average monthly living expenses and you need to save 6 months up to 1 year worth of that. This is also enough just in case you get laid off in your job.

However, if you don’t have a lot of dependents or if you have other sources of income to support you, you might want to consider up to 3 months worth of your monthly living expenses.

Just remember if you were able to save for your emergency fund already, invest your extra cash in other types of investments where it can provide more interests for your money. Here are some of the options on where to invest your extra cash.

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Comments

11 Comments on Why do you need an Emergency Fund?

Extreme John on Thu, 29th Oct 2009 10:28 am

Without doubt excellent tips for putting together an emergency fund, not something many people think of.

[Reply]

Dana @ Online Knowledge on Thu, 29th Oct 2009 11:56 am

I think gold also can use as emergency fund. How do you think?

[Reply]

Tyrone Reply:
October 29th, 2009 at 12:18 pm

Although gold is a liquid commodity, I think it would still be better if the emergency fund is in the form of cash.

The saying that “cash is king” speaks louder in times of emergencies.

[Reply]

Devon Business Directory on Thu, 29th Oct 2009 10:44 pm

Great reminder, especially in today’s economy. Also there’s the consideration of having money to be able to take advantage of unexpected opportunities

[Reply]

Gabe | freebloghelp.com on Fri, 30th Oct 2009 12:31 am

Emergency funds are being used by over 10% of the US populations today due to unemployment. It’s crazy how many people can’t survive a few months without a job.

The primary reason is that they never had a good defense. They always think that a good offense (massive income) can solve their problems but that’s not true in most cases. Good spending and saving habits can help anyone in almost any situation.

[Reply]

nel@momwithwork on Fri, 30th Oct 2009 2:55 pm

i like this topic. i believe in buiding emergency fund first before going into real investments.

very important indeed for those raising families.well, it’s easy for singles to raise for emergency fund but for parents with children, you’ve got to save a larger amount for your emergency fund.

[Reply]

Tyrone Reply:
October 30th, 2009 at 3:05 pm

Yes, definitely building an emergency fund is easier for singles that’s why it’s always advisable to save early - during your singlehood.

Having dependents such as your family would entail a much larger amount of emergency fund that needs to be build.

[Reply]

Kristine on Fri, 30th Oct 2009 10:58 pm

Ahh, guilty as charged. When I got my first job..err, paid internship (it wasn’t in the Philippines), I never even got the chance to save. Well yeah, I saved some only to spend it in a vacation by the Baltic Sea. Now I’m back home and working, I regret a bit that I didn’t get to save back there. Now, I feel like I’m just fresh off from college.

Now I’m separating my ’spending account’ and my ’savings account’ from each other. I also don’t withdraw money out of PayPal, except when I need to pay my phone bills or the electric bills. Sigh. Money frustrations.

[Reply]

Erick on Sat, 31st Oct 2009 4:12 am