You need an Emergency Fund. Whether you like it or not. It’s easy to feel safe and comfortable in our job. If 2020 taught me anything it’s that nothing is as it seems. Preparing for the worst is the only way to protect yourself.
Whether, it’s a solid job, parents, or social security nothing is ever guaranteed. Before COVID-19, I felt unstoppable my job was going great. I used to think “I work in hospitality and people would never stop traveling.”
All of a sudden, the unimaginable happened everyone was stuck at home and on furlough I went. 6 months… Not knowing if I would do my job again. Thankfully, I had prepared myself for it. 4 months of expenses saved up spared me from liquidating my investments.
It’s easy to get excited about potential investments and forget about covering our rear. One thing has become apparent the true priority is to have a financial safety net.
Pros & Cons of an Emergency Fund
You’re probably thinking is there any negative? And also “we get it you are safer with it.” Stick with me you won’t regret it I promise. There is a reason why an Emergency Fund is the first step in “5 Ways to Stop Living Paycheck to Paycheck“.
PROS
Peace of Mind
Living on the edge always sounds like more fun than it’s worth. I started off wanting every penny I made to have a purpose. That could only be putting it to work right? Right… An emergency fund is not only purposeful, but it’s also vital. Knowing you are financially secure will make taking risks all the more enjoyable.
A Back-Up Plan
Whatever happens, you can always get out of a pinch. Of course, this fund should only be used for emergencies. I’ll plead guilty here. I’ve used it to pay a deposit on a flat in the past as I was running low on cash. In this case, you should always make it a priority to replenish the fund. Hopefully, you learned from GME that GameStop options aren’t an emergency.
Debt-Free
With an emergency fund, you’re protected from Credit Card (CC) debt. Although, CCs can be a great tool. Who doesn’t like a few miles?
They also come with extremely predatory interest rates between 14% and 35% APR. They might seem like a good solution to solve problems in the short-term. Yet, you soon end up in a vicious circle. With a few months of expenses set aside, you always have a safe solution.
CON
You might be wondering, how can there be any CONs? Well, there is just one – it’s a bit of a first-world problem though.
Inflation
Your emergency fund can be too big. What does that even mean?
Well once you have 6 months of expenses set aside the extra cash will lay prey to inflation. If you were to transfer additional savings to a high-interest saving account the money would be growing (Although less than 1 percent). You could also look into investing in market tracking funds like Vanguard’s VUSA which tracks the S&P 500. The market has seen a growth of 7% annually on average over 100 years.
Additionally investing your extra cash is a great opportunity to make use of your ISA allowance.
How much do you need?
There isn’t a one size fits all answer. How much you need in your Emergency Fund will depend on your circumstances.
Let’s say you are working in an at-risk job and live abroad. In that case, you will want to save 6 months worth of expenses. Whereas if you still live with your parents and have a job within a stable industry 3 months probably will be enough.
Furthermore, the country you live in will impact the amount you need to save. I live in the UK therefore I benefit from free healthcare. Whereas if you are based in the US, you’ll need to get closer to 6 months saved as a medical emergency could hit you hard.
When you are establishing your total sum. You should focus on the following expenses.
- Rent
- Utilities (WIFI, mobile phone, energy)
- Food (Groceries only)
- Transport
Everything necessary to survive. You shouldn’t include outings to the movies, your gym membership, or a shopping spree in it. Focus on what your essentials cost you.
Once you’ve answered the questions above you should have your number. Keep in mind that it isn’t fixed. As you move house, country, or have a family – costs will change. I review my needs on a bi-annual basis and adapt my fund as I go.
Don’t forget any additional savings can go to building up your investment portfolio whether it’s with Trading 212 (Get a free share valued up to £100/$100 with my link) or Vanguard.
How did I set my Emergency Fund up?
- I calculated my monthly expenses and reviewed the conditions of my work package (Severance pay) so I knew what I was entitled to. It led me to a targeted total of 3.5 months of expenses.
- I opened a separate bank account at my bank. Although it is easily accessible it makes sure I don’t tap into my fund inadvertently. I personally recommend Virgin Money’s Current Account. As you get 2% interest rate up to £1000 and 0.5% on the remainder of your money.
- Track your spending and round up. As I track my daily spending with Emma (AFL) I can track how much I spend weekly and round it up to the next £5. That way, at the end of the month I transfer the total to my Emergency savings. If you use the cash you could put the coins aside when you break a note.
- Automatic Transfers. I can save a minimum of £700 a month so I set up a standing order to my emergency account on payday. I make sure no matter what that money is set aside.
- Do you get a bonus? I’m lucky enough to get a yearly company bonus. You know where I’m going with this it goes straight into the piggy bank.
- In the first year of setting up this account, I would check the balance quarterly. It took me around 18 months to build my safety net. I know can invest the money elsewhere!
- Priority Number 1. If ever I need to call on to the emergency fund my priority is to refill it as soon as possible.
What have we learnt about Emergency Funds?
Well, quite a bit so I decided to summarize the key points for you below.
Key points:
- Keep 3 to 6 months of expenses as an emergency fund.
- Review it frequently.
- Keep the money in a separate account.
I hope you enjoyed Cent by Cent’s first guide! I truly believe Emergency funds are often overlooked. Hopefully, you never need to tap into it, and peace of mind is priceless to achieve your financial goals. Feel free to share how many months you’ve set aside and how you built your Emergency fund.
