The importance of emergency funds: How to build and maintain a safety net

Chocolate Finance: Joanne, tell us, what exactly is an emergency fund?

Joanne: An emergency fund is a sum of money, set aside in cash, that you can turn to when an urgent and unexpected need crops up. Think of it as a trusty life raft for tough times.

When misfortune strikes, your emergency fund can step in to save the day, footing the bill for unexpected expenses and offering a layer of financial security. An emergency fund is like a tightrope walker’s safety net–it’s there to catch you when you fall. 

For example, your emergency fund could be used to pay unexpected medical bills or dental bills, or for surprise property/car repairs. And no, in case you were wondering, Taylor Swift tickets are not considered an emergency! 😂

So what’s the difference between emergency funds and savings?

Joanne: Unlike regular savings, your emergency fund should only be used for expenses that are unexpected and unplanned. So, it can be used in an apocalypse, but not a shopping spree!  As for expenses that can be planned for in advance, such as routine medical checkups, dental visits, or car servicing, you should make room for them in your monthly budget, saving up over time or cutting down on other expenses if necessary.

Why is an emergency fund important and what are the benefits of having one?

Joanne: You’ll be so glad you’ve built your emergency fund as it offers many practical and psychological benefits.

‍Firstly it acts as a financial safety net. An emergency fund ensures you are always financially prepared for any situation. No matter what happens, you’ll always have cash on hand and won’t need to get into credit card debt.

‍And secondly, it can help to lower stress levels. Modern life is stressful enough without having to worry about how you would cope financially in an emergency. An emergency fund gives you a layer of financial security that can offer peace of mind.

When is the right time to use your emergency fund?

Joanne: Before you dip into your emergency fund, stop and ask yourself the following questions:

1. Is this an unexpected, urgent expense?

As its name suggests, an emergency fund is meant to be used only in an emergency. Emergency expenses can include medical or dental bills arising from an unexpected illness or accident, or unanticipated home or vehicle repairs.  Instead of worrying about how you’ll be able to afford the bill, you’ll be able to pay right away in cash.

When it comes to expenses that can be planned for, put your hands in the air and step away from your emergency fund! You can plan for such expenses in advance, so take the time to save up for them. If you are not able to afford them, you might need to revise your monthly budget to be better able to live within your means.‍

2. Do I have the cash to pay this expense without dipping into my emergency fund?

The emergency fund is protection from falling into debt and can save you from turning to personal loans or credit cards, which can eventually lead to more serious problems like spiralling debt but no need dip into your emergency fund

if you already have the cash on hand to pay for an unexpected expense.

3. Have I lost my income stream? (e.g. job loss)

If you find your income from work suddenly cut off, your emergency fund can prevent you from falling into debt, making a stressful situation less painful and enabling you to focus on getting back on your feet.

How can you establish an emergency fund?

Joanne: Building an emergency fund requires some discipline, but is actually simple. If you’ve ever successfully saved up for a big-ticket item, you already have what it takes to build an emergency fund!

Firstly, Work out how much to save and for how long. A good starting point would be first to decide how much you wish to place in your emergency fund. A common rule of thumb is three to six months of your monthly living expenses. Next, evaluate your monthly budget and determine how much cash you can afford to set aside each month and for how long.

Then start putting aside money regularly to ensure that the sum of money you have pledged to set aside each month finds its way into your emergency fund. If you have enough discipline, you can simply transfer money each month into the bank account holding your emergency fund.

Otherwise, you might prefer to set up an automatic transfer that takes place soon after you receive your salary each month. This can be done via internet banking.

Liquidity is important–you want easy access to your cash in a pinch. So, avoid putting your emergency fund in a fixed deposit or any other products that limit access to your money.

‍You need to try to maintain the sum of money in your emergency fund. Once your emergency fund has been established, you should ensure the sum of money within is maintained. Whenever you dip into your emergency fund, aim to replenish it as soon as possible after spending.

How much money should you have in an emergency fund?

Joanne: This is a common question and the answer is, it really depends!”

There are a few factors to consider.

There is no hard and fast rule as to how much you should keep in your emergency fund. Much will depend on your monthly income, your income stability, your lifestyle and expenses, your dependents, the potential needs of your household, your wealth, and your assets.

The General rule of thumb is three to six months of monthly expenses.

But bear in mind that everyone’s situation is different, the conventional advice is to keep at least three to six months’ worth of your typical monthly expenses in your emergency fund.

If you have a stable job as a salaried employee, do not have dependents, spend well below your means, and live a relatively modest lifestyle with no car, you might be perfectly comfortable keeping three months’ worth of your monthly expenses in your emergency fund.

On the other hand, if you are self-employed with a fluctuating income, are your family’s main breadwinner, or do not have much cash to spare at the end of each month, you might feel safer keeping six months’ worth of monthly expenses in your emergency fund.

Can you share some strategies to help build an emergency fund?

Joanne: Sure, if you want to build an emergency fund but can’t seem to find the cash or the discipline to do so? Here are some tips:

Revise your budget

Don’t have enough left over each month to contribute to your emergency fund? Then you might need to make room in your budget for it.

Start by tracking your spending so you understand where your money is going, and then see where you can cut back in order to free up cash for your emergency fund. You might be surprised to find that you’re wasting money on little things like takeaway coffees before work or online subscriptions you never use.

Break it down into smaller goals

While the total amount of cash you need might sound daunting at first, your goal of building an emergency fund will start to feel more achievable once you break it down into smaller goals.

For instance, you might decide to set aside $200 a month for a total of 12 months in order to build up a full emergency fund. Little by little, you’re sure to achieve your goal.

Automate your savings

To ensure you don’t unwittingly spend money that could be put in your emergency fund, set up an automatic bank transfer that will transfer your contributions to your emergency fund once you receive your monthly salary. Set it and forget it!

Where would you recommend to keep an emergency fund?

Joanne: Your emergency fund should offer easy access to liquid cash, even at short notice. It is a good idea to keep the cash in your emergency fund separate from the money you use for your daily expenses so you don’t “accidentally” spend it at the bar!

One option is to open a separate savings account for your emergency fund. To make life easier for yourself, consider how convenient it would be to transfer cash between your regular savings account and your emergency fund. For example, using accounts in the same bank can make transfers faster and simpler.

Most people place their emergency funds in a savings account. The problem with savings accounts is that they typically earn dismal interest rates.

One smarter option: is to use a cash managed account, choose one with no hoops to jump through, no minimum balances and one you can withdraw instantly from. And just like a savings account, your money enjoys high liquidity – you can withdraw cash whenever you like instantly.

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So what tips can you share to help maintain an emergency fund?

Joanne: Your emergency fund should be replenished as soon as possible after you have dipped into it. Here are some tips for maintaining it:

Keep a record of how much you have used

Whenever you dip into your emergency fund, don’t forget to pay the money back in as soon as you can.

For instance, if you spend $1,000, you should immediately make a note to remind yourself that you need to repay $1,000 into your emergency fund. If, a month later, you repay $400 into your emergency fund, you should note that $600 remains to be repaid. Google Calendar is a useful tool for such reminders.

Come up with a plan to replenish your emergency fund

Whenever you spend any money in your emergency fund, plan to put aside money regularly to replenish it as soon as possible. By coming up with a plan right away, you get any pesky decision-making out of the way fast.

For instance, if you have used $800 in your emergency fund, you might plan to repay $200 a month to your emergency fund for a period of four months.

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A big thank you to Joanne Poh for sharing her expert insights and practical advice on emergency funds. Her guidance will be invaluable to our readers in building and maintaining a dependable financial safety net. Always remember to consider your individual financial circumstances and consult with a professional if needed.

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