Not many people understand the importance of having an emergency fund, but those who have had to deal with large and unforeseen expenses, and who have an emergency fund account appreciate how important it is.
What is an emergency fund account?
An emergency fund account is basically an account where you set aside a small percentage of your monthly income; separate from your regular savings, and which you can dip into in the event of an emergency.
An emergency fund can help you look forward to the future without worrying about being unprepared for emergencies.
Setting up your emergency fund
As a financially security-conscious individual, you likely already operate at least two types of accounts.
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A current account for your regular bills and expenses
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A savings account for long term savings
But these two accounts may not be enough to secure your financial future. There is also the need to set up a retirement fund account or a retirement nest egg for when you are no longer able to work. It is like saving money for a rainy day. This money will help you live a comfortable life after retirement. However, your financial plan for the future is at risk if you always have to ‘borrow’ money from your retirement funds or savings account to deal with emergencies. This is why you should also have an emergency fund account.
Experts suggest saving at least 6 months worth of your net living in an emergency fund account. This means that if your family requires £3000 in a month for regular expenses, then you should endeavour to have at least £18000 in interest-bearing savings account for emergencies. This may seem like a lot of money, but if you are consistent over time, you will hit this mark, and you can then forget all about it until such a time when you need emergency funds.
Reasons why you should have an emergency fund account
If you don’t have an emergency fund account, and you are hit with unforeseen expenses, you will be forced to dip into your savings, and this can significantly derail your savings goals.
While it is true that no one wants to spend their time contemplating negative scenarios, it is always helpful to be financially prepared for when the unforeseen occurs.
Here are some of the things that warrant an emergency account:
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In the event of job loss
Job loss is usually the primary reason people set aside cash for emergencies. It is important to have some money set aside in the event that you lose your job for any purpose. This is money you can live on for at least six months while you are looking for a new job.
If job loss is your reason for creating an emergency fund account, you may want to take into consideration the employment market in your region to determine how much you will set aside each month, as the harder it is to get a job, the longer you will be in the labour market, and the more money you will need to live on.
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Major medical expenses
Serious health challenge could create major financial strain for you if you don’t have a ready source of emergency cash. Of course, if you have health insurance, some part of the expenses will be covered by your policy, but you will still have to raise money for your co-payments and policy deductibles.
The situation is worse for people without any form of health insurance. When you don’t have health insurance, a major medical challenge can eat out a huge chunk of your savings, unless you have emergency funds set aside for such a situation.
The same thing applies to major dental surgery. Not everyone has dental coverage, and where you require a major dental procedure, you can always dip into your emergency account for the needed funds.
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Extensive repairs
Certain repairs require more than the limit on your credit card, and even when you have unlimited credit, it is never a good idea to encourage debts.
If you are faced with a major car repair project, your emergency fund account will help you meet your payments without hurting your savings account.
The same thing applies to when you need to carry out essential repairs in your home. It could be fixing a leaking roof, overhauling your electrical or plumbing system, or remodelling the kitchen. Any of these projects will cost a sizable amount of money, and removing this amount from your savings or retirement funds will put your financial plans at risk. But when you have an emergency savings fund, you can fund the repairs from your emergency account, and then take your time to grow your fund again.
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Sudden death
Sudden death in the family or of a friend could require you to purchase a last-minute flight ticket at an expensive price because you must be at the funeral. This is not the type of debt to have on your credit card, but something you can easily pay for from your emergency fund account.
In the same vein, sudden death in the family requires funeral arrangements, and this is something that can be funded from your emergency account. Even if your loved one had life insurance, it could take some time before the money is processed, and your emergency fund could serve as a source of cash for making the needed payments while you wait for the insurance benefits.
