Life is full of surprises, and not all of them are pleasant. You never know when you might face an unexpected expense, such as a medical bill, a car repair, or a job loss. That’s why having an emergency fund is essential for your financial security and peace of mind.
An emergency fund is a savings account that you can access quickly and easily in case of an urgent need. It can help you cover the costs of emergencies without having to borrow money, use your credit card, or dip into your long-term savings. By doing so, you can avoid paying high interest rates, fees, and penalties, and protect your credit score and future goals.
But how much should you save for an emergency fund? And how can you build one if you are struggling with debt? Let us look closer at how you can make an emergency fund work for you.
How much should you save for an emergency fund?
The answer to this question depends on your personal situation and preferences. However, a general rule of thumb is to have enough money to cover three to six months of your essential living expenses. This includes things like rent or mortgage, food, utilities, transport, insurance, and minimum debt payments.
To calculate how much you need, you can use a budget planner or a spreadsheet to list all your monthly expenses and income. Then, multiply your total expenses by three or six to get the amount of your emergency fund goal. For example, if your monthly expenses are R10 000, you should aim to save R30 000 to R60 000 for your emergency fund.
Of course, this is just a guideline, and you can adjust it according to your needs and comfort level. Some factors that may affect how much you need include:
Your income stability: If you have a steady and reliable income, you may need less than someone who has a variable or seasonal income.
Your family size and dependents: If you have children or other people who rely on you financially, you may need more than someone who is single or has no dependents.
Your lifestyle and spending habits: If you have a frugal lifestyle and can easily cut back on non-essential expenses in case of an emergency, you may need less than someone who has a lavish lifestyle and high fixed costs.
Your risk tolerance and financial goals: If you are comfortable with taking some risks and have other savings or investments that you can use in case of an emergency, you may need less than someone who prefers to be safe and secure and has no other financial cushion.
How can you build an emergency fund if you are in debt?
Saving for an emergency fund may seem impossible if you are drowning in debt. However, it is not only possible but also necessary. Having an emergency fund can help you avoid getting into more debt or feeling like you need to run from your debt or falling behind on your existing debt payments when something unexpected happens.
Here are some steps that you can take to build an emergency fund while paying off your debt:
You don’t have to save three to six months of expenses right away. You can start with a smaller goal, such as R1 000 or R5 000, and gradually increase it as you pay off your debt. This will give you a sense of achievement and motivation to keep saving.
Pay yourself first:
Before you pay any bills or spend any money, set aside a portion of your income for your emergency fund. You can do this by setting up an automatic transfer from your checking account to your savings account every time you get paid. This way, you won’t be tempted to spend the money on something else.
Cut back on unnecessary expenses:
Look for ways to reduce your spending on things that are not essential for your survival or happiness. For example, you can cancel subscriptions that you don’t use, cook at home instead of eating out, shop around for cheaper insurance or utility providers, or sell items that you don’t need or want.
Increase your income:
Look for ways to earn more money that you can put towards your emergency fund. For example, you can ask for a raise or a bonus at work, take on a side hustle or a part-time job, sell your skills or services online, or rent out a spare room or parking space.
Use windfalls wisely:
If you receive any extra money from sources such as tax refunds, bonuses, gifts, inheritance, or lottery winnings, don’t spend it all on something frivolous. Instead, use at least some of it to boost your emergency fund.
Where should you keep your emergency fund?
The best place to keep your emergency fund is in a separate savings account that is easy to access but hard to touch. This means that the account should have the following features:
You should be able to withdraw your money quickly and easily without any fees or penalties.
You should not expose your money to any market fluctuations or potential losses. Your principal and interest should be guaranteed and insured.
You should not be able to access your money with a debit card or an ATM. You should also not link your account to your checking account or any other accounts that you use for regular transactions.
Some examples of accounts that meet these criteria include:
High-yield savings accounts:
These are online savings accounts that offer higher interest rates than traditional savings accounts. They are usually FDIC-insured and have no minimum balance or monthly fees. However, they may have some limitations on the number of withdrawals or transfers per month.
Money market accounts:
These are hybrid accounts that combine the features of savings and checking accounts. They offer higher interest rates than savings accounts and allow you to write checks or use a debit card. However, they may have a higher minimum balance requirement and some limitations on the number of transactions per month.
Certificates of deposit (CDs):
These are fixed-term deposits that offer higher interest rates than savings accounts. However, they have lower liquidity and a higher risk than savings accounts. You must commit your money for a certain period of time, such as six months or one year, and pay a penalty if you withdraw it before the maturity date.