What is an emergency fund: money you have stashed away to act as a security blanket to deal with unexpected events.
Sh1t happens, it’s just a part of life.
Sometimes you have to face the unexpected, whether it’s losing a job, a loved one, or being in an accident. The last thing you want to do is put additional stress on yourself by not being financially ready for such events. The best precaution you can take from a financial perspective is to set up an emergency fund for those rainy days.
There is no one size fits all rule on how much you should have put aside in your emergency fund, everyone is different. But in this blog post, we will discuss all of the factors you should take into account when deciding how much money to keep for emergencies as well as where you should keep it.
Rule of Thumb
The general advice that is given by most financial advisors is that your emergency fund should be big enough to at least cover 3 – 6 months’ worth of expenses in a situation where you have no income.
Factors to consider when deciding your Emergency Fund size
Everybody’s circumstances will be completely different and you need to be realistic about what your potential needs are. Some factors may require you to have a much bigger emergency fund compared to others.
Here are some factors that may require your to rethink how big your fund size should be:
- No. of dependents
- Are you self-employed or have a regular stable-paying job?
- Stability of your job or business
- Your overall health
- Existing loan repayments
- If you are renting or a homeowner
Tips on Building an Emergency Fund
Set up a direct debit or auto transfer to your emergency fund
It can take a bit of discipline to get your emergency fund to the level you need. The last thing you want is setbacks because you either forget to send your money from your current spending pot, to your emergency fund or ignore it and waste it on something you don’t particularly need.
To avoid this you can set up an automatic transfer to your emergency fund, set to the day after you get paid. This ensures that you routinely build your fund within the time you had planned so you can then move on to looking after the rest of your financial goals.
Start a savings plan
If you do not know how much you plan on committing to your emergency fund before you start, you will have no idea how long it will take to get there or how much you should be saving each week or month. When you have a target everything becomes clearer and you can work backward to know how much you need to save regularly to reach that target.
Even a simple plan such as saving €1 on the first week, €2 on the second week, €3 on the third week… €52 on the 52nd week will leave you with €1,378 at the end of the year.
Have an accountability buddy
An accountability buddy is someone you partner with to tackle a common goal. Maybe you have a family member in a similar situation who needs to build up an emergency fund also. You could agree on a plan together and meet for a coffee at the end of the month to compare notes and motivate each other.
Draw up a list of what counts as emergencies
When there is a pile of cash building up in your emergency fund, then so too will your temptation to dip into it. You might even stretch the definition of what you consider an emergency as an excuse to dip into the fund.
To avoid this happening at the outset you should list out situations that would be real emergencies that would cause you to use your funds. This may stop you from using it for ’emergency’ shopping trips.
You may be able to give yourself a head start by doing a thorough review of your current monthly expenses. You may be surprised at how many different direct debits or subscriptions you have signed up for that you don’t use anymore. At a click of a button, some of these can be cancelled and you are already off to a great start.
Where to Keep your Fund?
The key reason you set up an emergency fund is that you will be able to access it at a moment’s notice and this should be the key criteria you use to assess where to keep the money. Let’s evaluate some options:
Stocks – this is not a great option as it may take a few business days to get access to cash. You will have to wait until the market opens to sell your stocks and then wait for the trades to settle before being able to withdraw the cash by bank transfer to your own personal account. This will all take time and would not be ideal if you need cash instantly.
There is also the added risk that your emergency fund could lose value in a market crash. Although indexes such as the S&P 500 have had fantastic returns over the last few decades, it does often see large period adjustments and crashes.
Government Savings Certs – Although these are a very safe place to keep your funds as all Bonds are 100% guaranteed by the State. The interest rates on these products are very low (5 Year Cert 0.59% AER) and will not compensate you enough to cover current inflation rates. Another reason that Government Saving Certs might be a bad idea is that you need to give 7 days’ notice if you want to redeem your cert.
Prize Bonds – Again these are 100% guaranteed by the State, instead of earning interest on your investment, you will be entered into a weekly lottery where you could earn up to €50k per week. There is a minimum hold period for a Prize Bond that is 3 months so once you start investing in Prize Bonds your emergency fund will not be accessible for a while.
The cash-out process will also take some time, you will need to fill out a repayment form and send it off before you get your money back. So again this falls down when it comes to timeliness of access.
Deposit account linked to your current account – The simplest option is often the best one to go with. A deposit account will not give you anywhere enough interest to cover inflation but the major advantage it has is that you can access it at a moment’s notice.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.