Why You Need an Emergency Fund

June 22 2020 | Category: Money advice

When we work with new clients to help them plan for the future, one of the first things we talk about is an emergency fund. Mainly, if they have one in place or not. If they have – great! They are already one step ahead in the game. But if they don’t then part of their long-term financial planning will be creating and building up an emergency fund. But we do get asked if everyone needs an emergency fund, and why, quite a lot, along with how much should be in it, and when is the appropriate time to use it. So we’re going to answer these questions today, and a few more besides.

What is An Emergency Fund?

An emergency fund is pretty much what it says on the tin. It’s a fund that you can use for emergencies. It usually takes the form of an instant-access savings account, which gives you a readily available source of cash to help you in case of an unforeseen event. Like, for example, a global pandemic that means you’re suddenly unable to work.

For most people, their go-to reason for building up an emergency fund is to tide them over in case they suddenly lose their job. But in reality an emergency fund can be used to cover pretty much any important unforeseen event. A few examples include losing your job, a debilitating illness, major repairs to your home or car, big vet bills, or to tide you over during a crisis, like Covid-19.

Typically, experts will say that you need around 3 months salary sitting in an emergency fund at all times.

Why 3 Months?

3 months salary might seem like an odd choice, but there is a good reason behind it. 3 months salary for most is not an insignificant amount of money and will provide you with a stable income for 3 months should your other income drop off completely. For most people, 3 months is enough time to find another job, and wait out the first month before a pay check comes in. It means you don’t have to worry about how the bills will be paid, or how you’re going to afford food. In short, it gives you peace of mind, and having that level of savings can actually bring your stress levels down. The other reason is that 3 months’ salary will usually be enough to cover emergency bills, like house/car repairs or vets, hopefully with some left spare. This means you won’t need to dip into your current account to top it up, and it won’t interrupt your planned budget for the month.

How Do I Do That?

The way you build up your emergency fund will depend a lot on your income, how stable it is, your other expenses and any other goals you have in the short, medium and long term. The simple solution is to start putting away a small amount of money each month into a high-interest instant access bank account, where you don’t touch it and instead let it build up interest. If you know how much is coming in and going out of your account each month, you can even commit to putting a percentage away each month until you hit the 3-month mark. We recommend you talk to a financial planner, who can help you create an emergency savings plan that won’t impact your day to day life.

If you ever need to dip into the emergency fund, don’t panic. Wait until the reason for the spending has passed (since it might be a one-off, or it might be ongoing depending on the reason), and then start to top it up again. This might mean diverting some of your other savings efforts for a little while, but once your emergency fund is back up to that 3 months salary mark (or whatever you choose), you can move back to your original plan.

What Do I Do Next?

Start saving! But if you don’t have a financial plan in place already, with a roadmap to help you achieve your goals, we recommend you talk to a financial planner first. They will be able to help you understand your current financial situation, look at what your goals are, and build a tailored plan to help you build up an emergency fund without causing problems. This way, you won’t have to dip into your emergency fund right away because you put too much into building that up, and suddenly don’t have enough to live on!

Building up an emergency fund is an important part of good financial planning, and it will help ensure you can survive if something were to happen, and finances would be one less stress for you to deal with, at least for a while. At Chilvester Financial, we love helping individuals and families of all ages, shapes and sizes plan for their financial future, and a big part of that is creating a savings and emergency fund that’s right for their unique circumstances, along with a plan to help them build it up in a way that works for them. If you would like to know more about financial planning for an emergency, or just for the future, just get in touch with the team today.