In this world of development and progress, finance is compelling evidence of such progress where many unfamiliar terms are encountered. A good example is the term: “emergency fund.” So what are an emergency fund and the reasons you need to build one?
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Emergency Fund Basics
When referring to an emergency fund, this term pertains to the collected amount of money in savings to pay for financial emergencies such as sicknesses, job loss, or other significant unexpected expenses that must be urgently paid off.
According to financial experts, this sum of money is estimated to be equivalent to three to six months of gross salary held in the most liquid and secure form possible. Therefore, it is highly recommended to save an emergency fund in cash-equivalent bank accounts or interest-earning saving accounts where depositing funds does not require any taxation, penalties, or even sometimes any intermediary interest fees to the third parties. In addition, in the US, checking, savings, and certificates of deposit (CD) accounts are often insured up to $250,000. This term is known as FDIC insured.
Yet, some people risk their emergency funds while investing them in stocks, cryptocurrency exchanges, and mutual funds, where the values may drop dramatically. In this case, an individual may eventually lose their principal. The whole world is currently closely familiar with the concept of prior financial preparation and understands the importance of the emergency funds especially after the COVID-19 outbreak. In many countries, a quarantine was imposed with all the repercussions on daily living. In addition, some people lost their jobs and certainly needed an emergency fund.
9 Reasons to Build an Emergency Fund
Almost everyone thinks about securing and insuring themselves against the unexpected. Here are nine reasons why someone should consider building an emergency fund.
No individual would instead fall into the vicious cycle of paying out debts or having reductions in their retirement accounts or pensions because of penalties or interest on the debt. This cycle will overload the individual with additional expenditures throughout their lifetime. After all, saving money seems to be the most rationally convenient option.
2. Losing a Job
A common unexpected scenario can occur anytime during our lifetime. However, a struggle may begin once the individual is cut from a regular incoming paycheck after losing a job. They may now struggle to afford necessities. With the rule of thumb, the threshold of saving you need to keep as an emergency fund should be a minimum of three months because there may be other dependents relying on this individual, especially if they are the only income earner in a family. However, some experts recommend six months for an emergency fund and even longer.
Priorities should permanently be firmly settled and backed up. Health is the primary reason why someone needs to safeguard their finances. The reason behind it is not to fall into the trap of being incapable of supporting the improvement and treatment of yourself or your relatives’ health who are dependent on you. After all, health keeps us on our feet and is needed to meet our financial needs.
Gas lines in the household for heating or cooking, cars for transportation, or the water pipes for daily use are substantial needs to satisfy and handle the necessities. Living without electricity, gas, water, or even any vehicle is pretty much a hassle. An emergency fund can help address the unexpected repairs in the home.
A week of frigid temperatures outside, and the house needs to be thoroughly heated. However, this heating will occur throughout the entire week over 24 hours each day, which will incur a huge bill to be paid off at the end of the month. The family should always be prepared for such surprising expenditures.
Last-minute airline tickets are needed when an unfortunate death of a relative happens. The prices could be high, and the significant expense could linger on the credit card bills. However, once your emergency fund is ready, you have nothing to worry about anymore.
A funeral is an unfortunate scenario that costs not only the loss of a loved one but an excessive amount of expense that can be thousands of dollars. An emergency fund can help deal with funeral costs.
Life is full of ups and downs. An individuals’ status jumps from dependent to independent status as they grow older. This point is the stage of life where, for instance, university graduates begin making their living and start to take care of themselves and their family members or partners. A small emergency fund can help with the transition.
Natural disasters or catastrophes turn the life of the survivors upside-down. Not only would those individuals suffer from the loss of their properties, but the unexpected journey they need to undertake which the conditions have compelled them. The trip may include moving to a new city, relocating to a new house, and many other needs all covered thanks to the supporting NGOs, the government’s budget assistance, or the last case scenario by individuals themselves with their emergency fund.
1. Several Small Steps Rather Than a Big One:
The psychological concept behind this method is the motivation towards success made through the small, targeted goals rather than pushing ourselves to take a massive leap of a complex challenge. The latter could be a cause for giving up and not being willing to build an emergency fund. A typical example is setting a target of saving a certain amount per week and managing to hold half of our annual salary and after the initial goal is met, then pushing ourselves to put aside immediately a more significant amount later.
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Again, this has much to do with the success and psychology of human beings. Every little success fulfilled compels the individual to proceed accordingly and make more achievements. Sometimes, these small regular targets incentivize the individual to save an extra amount of money at an individual’s convenience and discretion.
If the savings were intended to build an emergency fund, we should never use them for unnecessary occasions or needs. However, the savings process is already a committed and easy plan to achieve. So acknowledging the purpose and the worth of saving for an emergency fund would discourage us from using the money. Therefore, freeze the account for only emergency needs. If you need to savor other items you can try saving in a sinking fund.
After taxation, any disposable income that is left aside could be either deposited into an emergency fund or used for something else. However, if your target emergency fund dollar value is reached, it would be better to have the extra money invested elsewhere, where the money can grow, rather than putting away more money into the savings account when the target has been already reached, and the interest rates are often lower.
5. Be informed About Your Rights:
Knowing what the government is providing as assistance or the facilities that a citizen of a specific country could benefit from would allow you to rethink establishing an emergency fund’s reasons, purposes, and methods. For example, if the government takes care of all the damages incurred from natural catastrophes, our focus would be on saving for individual needs and reestablishing the emergency fund goals.
Summary About Emergency Fund Basics: 9 Reasons to Build an Emergency Fund
To sum up our discussion, despite all the securities and insurances provided in life, human beings constantly seek additional safeties to guarantee themselves from any unexpected events in life. Therefore, self-organized emergency funds are among the best alternatives to insulate themselves from extreme and unpredictable accidents in life.
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Thanks for reading Emergency Fund Basics: 9 Reasons to Build an Emergency Fund!
Author Bio: This is a guest post by Robert McMillen. Robert McMillen is an entrepreneur, finance professional, consultant, and passionate writer at Instant Loan Online. Using his industry knowledge and experience, he has helped his clients create more wealth and reduce costs for many years.
You can also read Reasons You Need an Emergency Fund.
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