An emergency fund is like insurance. We have health insurance to cover for our medical expenses, and we have car insurance to cover for a potential accident, an emergency fund does the same thing when we face a financial emergency. We pay ahead for the ease of mind of knowing that if life throws us a curveball, we have the necessary means to face it.
What is an emergency fund?
Inevitably, we all experience things we never thought we would. An unexpected layoff, an abusive relationship, a fire in our house, a serious health condition, the loss of a loved one, harassment at work… All of which already challenging situations by themselves and capable of turning our lives upside down. If we add to the mix the uncertainty of a bank account unable to respond to the demands of everyday life in that situation… then we might meet crippling anxiety, emotional and psychological instability.
An emergency fund is like a soft landing place, that protects us from crashing and burning. That allows us to break off a dysfunctional relationship without considering the financial impacts, that gives us the ability to tell our manager to fuck off without resorting to mental math if we’ll be able to pay for rent, in sum, it allows to live comfortably when our main source of income suddenly disappears.
Now imagine how you would feel if you knew your emergency fund bank account has enough money for you live off easily for 6 months up to a year? What type of decisions would you make? What possibilities would open up?
In general, people who experienced significant challenges understand the need for an emergency fund. Unfortunately, the rest might only get it when they’re already in the midst of an emergency. But it doesn’t have to be that way. If you don’t have an emergency fund yet, the most important thing is that you start saving right now, and no amount is too small to start with.
How much should you save for your emergency fund?
To figure out how much you should have in your emergency fund, you have to get clear on your exact monthly living expenses. To do that, go through your bank statements for the last 3 months, gather all the information you need and calculate the total amount of your monthly living expenses.
Your emergency fund will be based on that amount. Next, reflect on these questions:
1. How easily and quickly could you replace your current income in case you lost it?
2. If you lost your job, how much time do you think you would need to find a new one?
The harder and slower the process of finding alternative income sources, the bigger your emergency fund needs to be. So, if in your case you can easily and quickly transition from one job to another, a 6 months emergency fund might be enough for you. If that’s not the case, and you reckon it would take you a bit longer or if you’re a freelancer or an entrepreneur, it’s best to have an emergency fund to cover for 12 months.
How to build a good emergency fund?
The first step is often the hardest, and don’t be surprised if your motivation plummets as you acknowledge the size of the challenge you have ahead. If your monthly expenses average around €1000, it’s natural that saving €6000 (for a 6-month fund) or €12,000 (for a 12-month fund) would stir up some overwhelm, doubts and anxiety. Even though it is a large sum of money and the goal seems ambitious and distant, with commitment, dedication, and patience, know that it is possible to achieve.
Here’s a strategy to build a solid emergency fund:
1. Open a separate account
First of all, open up a specific account for your emergency fund. You want that money away from your current everyday account so that you’re not tempted to use that money for other purposes, yet you want it within reach so that you can easily access the money when you really need to.
One of the options is to create a savings account with no maintenance fees. The option we recommend is having that money invested in a Bondora account, which is a fintech that offers up to 6,75% of return on investment with daily liquidity, meaning that you can withdraw that money whenever you want or need to, in the meantime, it’s bringing you a reasonable investment.
2. The first month
Your first goal will be to set aside enough money to cover for one month of living. Regardless of how much time you need to achieve that goal, focus on small actions and baby steps. Define how much you want to put aside each month to accomplish this milestone without being overly ambitious or you could get frustrated, but do commit to assigning any extra money you make into your emergency fund, such as bonuses and any other additional income.
3. Cut out the unnecessary
Then, get really honest and try to cut out your most superficial expenses, such as eating out, going out at night, or impulsive shopping. We’re not trying to push you to a life of austerity, but rather that you reassess what is really important and what brings you joy and meaning. During these first few weeks, it’s essential that you look at it like a financial makeover intensive training, where your primary goal is to learn healthier, more congruent ways of saving and spending your money.
It’s likely that in this process you’ll come to discover abilities and skills unfamiliar to you thus far. Make use of your creativity to find ways to complement your current income so that you can use that extra money to set aside to your emergency fund project. You can sell things that you no longer use or need, you can work extra hours, babysit, dogsit, teach English classes, or any sports, plan workshops or consult in your field of expertise. With a little bit of willingness and patience, possibilities are really endless. At the end of the day, it’s unlikely that you will regret this experience, regardless of the amount of money it brings in, what you learn about yourself and life, and what you do for others will prove valuable and fulfilling enough by themselves.
5. Keep going
Once you reach your goal, don’t stop, Keep saving to invest, to travel, to take a year-off. Working for what really matters and what makes a difference in our lives is a lifelong practice, a never-ending mission. And what you learn in that path is just, if not more rewarding than reaching the goal itself.
What questions should you ask before you decide to use your emergency fund?
And lastly, how do you make sure you only use that money in case of a true emergency? There are 3 questions that help clarify whether or not the situation at hands calls for a withdrawal of your emergency fund:
1. Is it absolutely necessary to use the emergency fund?
2. Is this an unexpected situation?
3. Is it an emergency?
If you answer no to any of these questions, consider some other options before you use these savings. We hope this helps, now go out and start saving.