In today's taxing economy, everything can change in a blink. One minute you're enjoying a weekly movie date or night-out-of-town and the next minute you're slapped with medical bills and service fees that either immediately or gradually send you into the depths of bankruptcy. Ask any financial-savvy person about how you can best prepare for these worst case scenarios and you'll likely get Emergency Funds as the collective answer. Any effective long-term financial plan should incorporate an emergency fund and this guide will be giving you the step-by-step process on how you can build one.
What Are Emergency Funds?
Emergency funds have saved a ton of people from a ton of headache. At its most basic form, an emergency fund acts as a safety net in the event of an unforeseen financial crisis, such as a family member taken ill or being let go by your employer and losing your primary source of income. Contrary to what most people believe about emergency funds, it doesn't necessarily have to be purely cash-based. The fund can also consist of liquid or short-term investment assets that will favorably be accruing interest for as long as it's parked in your account.
You may be asking "If emergency funds were so dang great, why aren't more and more people joining the revolution for a more secure financial future?" Oftentimes, people refuse to start building their emergency funds since they view it as a form of punishment. After all, why would you voluntarily deprive yourself of the cash that you worked so hard for, right? Wrong. The idea behind emergency funds is to give you financial assistance during the gloomiest of times. Its purpose is to keep your lifestyle afloat until you find another source of income you can live on.
Set Your Starting Line
The first step, of course, is to set a target or goal. Most people who are either too enthusiastic or skeptical of their future set ridiculously high target numbers for their emergency funds. They soon find it hard if not impossible to accomplish their initial target and either set new ones that are too low or abandon the venture altogether.
If you are planning to build an emergency fund that is expected to last for 24 months, it is ludicrous to expect that you'll hit the target after only 12 months even while working two or three jobs or clocking in overtime hours. Instead, start with a more attainable and realistic goal like $300 or $500. Depending on your current pay grade, you can hit this target in a few months.
The great thing about setting an initial low target is that you also set yourself up for success. Every time you hit a target, you become empowered with the confidence and willpower to set out for higher targets.
Find Holes in Your Current Financial Plan
Having a target is great and brings you a step closer to your goal of having an emergency fund. Now the challenge is to find the money. Where are you going to get that $50 or $100 per week that you set out to do? Look at your current spending habits and monthly expenses and identify areas where you can reduce or completely eliminate costs.
Avoid Unnecessary Expenses.
Those bags of chips that offer no nutritional value or expensive restaurants dinners has got to stop. These lifestyle choices inflict heavy tariff on your budget and can restrict you from saving up for the future. Rather than buy name-brand peas or artisan cheeses, go for generic brand foods that offer the same taste, blend, and nutritional value.
Haggle With Credit Card Companies.
If you have outstanding balances on your credit card, you can save money per month by simply requesting for a reduction in your current interest rates. You will find the contact number of the bank at the back of the card. Ask to speak with the branch manager or supervisor and state your request.
Shop Smart.
Plan every visit to your local grocery or department store. Make a list of items you need to restock on, such as food and hygiene supplies. By preparing a list of items you need, you remain focused on the task at hand and minimize any tempting purchases like that new Apple smartphone or 60-inch flat screen on sale.
Avoid Splurging.
Rather than go out for a pricey dinner that doesn't even fill your belly, switch to a fancy meal prepared and served at home. If you take vacations to world-renowned resorts and travel hotspots once per month, try to cut it back to once per year.
Get Techie.
Installing a programmable thermostat in your humble abode can reduce your monthly electricity bills by as much as 30 percent. You don't even have to be that tech-savvy to do it, too. Instructions come with the programmable thermostat and setup is a breeze. Be sure to set the thermostat accordingly so that the furnace or AC doesn't run late at night or when you're outside of the house.
Switch To Public Transportation.
Public commutes can be irritating, especially if you manage to hop on a bus or train with the wrong crowd or if there are arrival/departure delays caused by track problems. Nonetheless, being a public commuter can save you a great deal of money that can be redirected towards your emergency fund. With car ownership, you pay for the loan, regular maintenance and servicing, insurance, gas, etc. Sure, you do get the privacy and comforts absent in public transportation, but the associated expenses barely leave money you can use for emergencies.
Automate the Process
Using the techniques listed above, you should now work on automating the process of saving money on a weekly, monthly, or yearly basis. Keeping track of things manually can be physically and mentally exhausting. Automating it gives you freedom to focus on other important things in life while simultaneously building a large enough emergency fund that braces you for anything and everything that comes your way.
So you've successfully been able to extract $20, $50, or $100 per week by rearranging your spending habits, but now you have money sitting around waiting to be used. You feel it calling you and you start picturing things you could buy with that wad of cash. Naturally, it's tempting to spend your emergency fund on something that gives immediate satisfaction rather than wait for an emergency to happen, but you don't really have to be tempted.
Ideally, you should set up an automated savings plan that grabs a portion of your paycheck every week or month and sends it to your savings account where it can't lure you into its seductive grip. Moreover, try to set up a separate bank account that manages your emergency funds. Combining it with an account you regularly use for business transactions will expose it to risk.
Keeping your money stored in a virtual bank account limits your access to the funds. you will typically have to sign in to your account from a secured computer, request a fund transfer, and then wait for one or two business days to get the money. This is sufficient time to process what you are doing and not get carried away by impulse spending. Traditionally, you could easily run to an ATM and withdraw some cash from your savings account, but online accounts have made it more convenient and secure to transact with vendors, friends, and colleagues.
Identify True Emergency Situations
Different people view situations differently. Some are prone to breaking the piggy bank at the pettiest of problems while others are smart enough to know when and where they should be tapping into their emergency funds. Apparently, new designer shoes or a big flat screen TV does not fall into the Emergency category. Below are some situations that merit withdrawals from your emergency funds.
Uninsured Health Expenses.
Minimize strain on your emergency fund by using a Health Savings Account, which is basically a savings account that marries together the qualities of a high-deductible insurance policy with tax benefits. In addition to minimizing impact on your emergency fund, opting for an HSA can also save you cash on tax-related expenses from acquired healthcare services.
Unplanned Family Emergencies.
As heartbreaking as they may be, family emergencies, such as a distant relative passing away or a family member suffering an accident, can spark the need to travel or make the necessary arrangements, which cost time and money. While you can also tap into loans from banks or private lenders, the process usually requires a longer waiting period for the application to get screened. And even then, you can't be sure you'll get approved by the lender.
Serious Vehicular Problems.
Although we advocate public commutes over car ownership, those who already own a car or really need it due to geographic challenges will incur expenses related to major car repairs, maintenance, and replacement parts. If you rely on your vehicle to get to work or is using it for your primary business, then immediate repairs, regardless of the financial costs involved, is imperative. In the future, establish routine car maintenance and include it in your monthly budget.
Major Appliance BreakDown.
An example would be your fridge or air conditioning system. If it suddenly stops to work, the living conditions inside the house are compromised. Either you pay to get the appliance repaired or you buy a new one. The decision lies with you. How long have you had the appliance for? Are the costs of replacing it lower than having it repaired on a frequent basis?
Major Home Repairs.
Floods, earthquakes, tornadoes, and wildfires are common causes of major property damage, and New Zealand has had a fair few of those in recent years. In addition, human-inflicted damages, such as vandalism or break-ins, can also expose you to unplanned expenses. Having access to emergency funds allows you to make quick property restoration at quality standards. Immediate home repairs are critical since unfixed damages to the property decreases its long-term value and can affect quality of living.
Ways To Help You Build Your Emergency Fund
Start your fund small and grow it over time. You might be surprised by how much you can stash away in as little as 6 months to get you started. Saving lots of money in a short time like this is known as ‘burst saving’, and usually requires you save upwards of 35% of your income. To help you get going, we have put together a set of 7 ways you can get that fund growing and quickly. They might not all be relevant to everyone, but there will be at least something here for all to consider in generating a much needed financial lifeline.
1. Open a savings account with the best interest rate you can find.
This is where you should start. It is critical to get the best rate of interest you can, to allow as much growth as you can get on your money. You want it to be an account that you can’t just dip into whenever you want, but not so secure that you can’t access the funds when you need it. The whole point of an emergency fund is to have quick access in an emergency, so locking it way in an account that won’t release the funds for weeks after a request just won’t do. Choose carefully and do your research as this will be the home for your fund.
After deducting everything you need for your essentials, deposit everything else into this account. If you leave expendable income in your normal current account you will squander it, and every cent is a potential saving.
2. No Pain No Gain – strip down to the bare essentials
You can live 6 months with no luxuries right? It’s only a short time in the grand scheme of things and if you want to really grow that fund you need to strip out all the non-essentials from your budget. Think of the budget like a car, currently fitted out with electric windows, pimped out stereo, luxury from door to door. What you want to do is strip it down to the chassis, the engine, the wheels and the seats. Ok seatbelts too, you can keep those. Everything else is unnecessary. So the first place to start here is in generating a budget, determine exactly what you need every month for your outgoings and essentials. Every other penny goes into that emergency fund. No takeaways, no trips to the cinema or the pub. It’s not forever its only for six months and the more you can slash off your spending the greater the fund you will build.
3. Move back in with the olds/family
If you really want to build a large emergency fund fast, and you have no binding ties to a property, can you consider moving back in with the olds or with family for a few months?
If the property you are in is rented, and you are not tied to it, and also if the family are willing to put up with you for a short while, you could save a large amount of money by moving back in. You will be saving on rates, rent, utilities and a whole host of other outgoings such as phone and internet. I’m not saying don’t contribute when home, but any contribution will be far less than going it alone. Even a few months of this should be enough time to generate a substantial fund.
4. House Share
If you can’t move back in home with family for whatever reason, or if you are tied to a property, could you house or flat share? Do you have a spare room you could let out? Taking in a lodger or renting out a spare room will slash your monthly commitments and allow you to put all that extra cash into your emergency fund. That’s if you can put up with each other.
5. Vouchers, Coupons and Value Brands
Those that take part in ‘extreme couponing’ might seem like a bit of a geeky bunch, but there is method to their madness. You can save an absolute fortune on your everyday shopping by collecting and using wads of coupons and vouchers. You might look at a coupon book or leaflet and think there is very little there you can use, but save up the ones you can, from every book or leaflet you can get your hands on and use them. All those 50% off, buy one get one free and similar offers stack up and can slash your shopping bill every month. Combine this with buying value brand items on everything you can and you can massively reduce your monthly shopping bill. This can add a substantial balance to your emergency fund, and again this is only for 6 months not forever. It’s all for the greater good.
6. Generate Additional Income
If you have overtime on offer, take as much as you can without exhausting yourself. If there is no overtime on offer, could you take some part time hours at another job, even a bar in the evenings? Delivering takeaways, courier driving, making craft items and selling them. Whatever opportunities you can create or that are open to you, take advantage of them and put all that additional cash into the emergency fund. If you struggle to work extra hours due to family commitments, and need your spare time at home, well there is plenty you can do there too. You could freelance, outsource call centre work from home, turn a craft into a family hobby in the evenings and sell the items. Get as imaginative as you like here and add whatever you can to that fund.
We have written an awesome post on increasing your income with additional work that will give you some ideas.
7. Any assets you don’t need?
Take a good look at what you have and what you use. If you have any items of value that have no or little use for you personally, that just sit accumulating dust, get them sold. Hoarding is counterproductive and you can turn that dormant item into extra cash. You could sell these online on auction or sales sites, or take part in regular weekend markets. Getting rid of these things clears space in the home and can add a good bit of value to your fund.
Each of these steps can add real and significant value to your emergency fund, and help you start out to quickly accumulate a useful balance. They might not all be applicable to everyone, but the more you can try, the greater the impact. They might require a significant lifestyle change in the short term, but it is only for a few month and the benefit you will create from setting up this fund can be the difference between hope and despair.
Investing Your Savings
As mentioned above, emergency funds can comprise of investment assets, but only those that are liquid and carry low to no risk. Unfortunately, the rewards you can reap on an investment is commensurate with the level of risk you carry. In other words, if you opt for a low-risk investment portfolio, you should expect a very slow growth rate on your account.
Investment vehicles that present the lowest risk include checking and savings accounts, certificate of deposits, and even physical money. In the past, government-backed securities like T-bills, bonds, and notes have been popular choices for low-risk, safe investing. Guaranteed payouts on these investment vehicles, however, have been questioned over the past decade, so they may not be necessarily guaranteed despite their low-risk nature.
Summary
Building an emergency fund can be an intimidating process, filled with highs and lows and obstacles lurking at every corner. Endeavoring to build a sufficiently sized emergency fund able to withstand financial cataclysms of any magnitude will require you to develop self-discipline and force you to confront your spending habits.
If you have yet to build your personal emergency fund for rainy days, start examining your spending habits and lifestyle. Use the information to develop short-term and long-term objectives. After which, identify situations that justify accessing the fund. Avoid blindly taking money out of the account without any important reason/s.
