Emergency fund – All the information you need

An emergency fund is an amount that, when calculated and invested correctly, can cover your needs at specific times.

As the name suggests, these moments must be emergencies, so your fund cannot be used for a leisure trip, for example.

As far as investment is concerned, it’s ideal because it’s designed to avoid losing money due to inflation.

Another essential point is that the investment has liquidity.

This means that it can be easily redeemed when the unexpected arrives.

In general, this anticipation is essential because it is the key to avoiding problems with debts.

It’s also important because you have a greater peace of mind about your future, without famous financial anxiety.

The importance of having an emergency fund

First, this strategy allows you to have financial stability.

When you have money saved that can be used in unforeseen circumstances, in times of crisis, you don’t need to apply for a loan to maintain your cost of living.

But you might think:

I have a stable career, I don’t need to worry about building up an emergency fund.

That’s a big mistake!

Who imagined that one day we would face a pandemic?

No one, but in just a few days, we had to close businesses, avoid crowds and stop going to work.

Some of us worked from home, others didn’t have the option, and the result was as follows:

The coronavirus pandemic increased credit card debt for 30% of Americans.

Most of these Americans probably thought one day: I have a stable career, I don’t need to worry about building up an emergency fund.

And when the time came, they had to resort to other alternatives and got into debt.

Even if you already have a stable career, you have to think that your financial life can be affected.

In The Psychology of Money, the author recommends that you always consider the worst-case scenario when making a decision.

Before determining that you won’t have an emergency fund, think about the worst-case scenario in which you no longer have your monthly source of income.

What will you do without your salary in 6 months?

Here, we can talk about the next benefit:

Emotional peace of mind.

If you have these resources available exclusively for unforeseen circumstances, you don’t have to worry so much about your financial situation.

Bear in mind that this strategy allows you to achieve a better quality of life.

Maintain your strategies and enjoy financial freedom

Another important point is that the fund helps investors maintain their strategies in the financial market.

If you’re an investor, you won’t be afraid to make contributions in times of crisis because you know you’re “protected” because you have an emergency fund.

What’s more, if you need money quickly, you won’t have to resort to withdrawing assets that could end up in losses due to price fluctuations on the market.

So you can avoid losses due to lack of planning.

On the other hand, it’s worth talking about financial freedom.

With your finances protected, you can make decisions involving your money with greater security and less worry.

For example, if you are dissatisfied with your current job, you can look for another one or even think about changing careers.

And this is not limited to work.

You can also plan to move house, go on a trip or buy a new car.

However, given all these advantages, you might think it’s too late to start.

The advantages mentioned above have no age limit and are suitable for anyone who is willing to change their lives.

While it’s true that the sooner you start, the better, that doesn’t mean you can’t prepare for unforeseen events when you get older.

Should everyone have an emergency fund?

Emergencies don’t just happen to one type of person.

Everyone has to deal with unforeseen events at some point in their life, so everyone needs an emergency fund.

Therefore, this should be part of the planning of anyone who has expenses in their routine, whether they are an individual or a company.

This is interesting because if you own a business, for example, you need two different funds.

The first is your personal fund to deal with day-to-day unforeseen events, and the second is your business fund to deal with emergencies in your business.

This should be clear in your mind because if you only have an emergency fund to deal with unforeseen events in the company and at home, what will you do if 2 unforeseen events happen at the same time?

In the case of the self-employed, for example, the money in the business fund can even be used to cover your own salary in times of low sales.

This way, you don’t have to compromise your personal budget.

Also, know that the fund is even more important for people who have individuals depending on them financially.

In other words, if you have children, relatives or even pets, you should worry about your fund.

How much do I need in my emergency fund?

Although everyone needs an emergency fund, the amount is not the same for everyone.

You should therefore make a calculation taking into account your fixed costs.

Many experts recommend that you have enough to cover expenses for 6 months.

However, depending on your family’s situation and your plans for the future, you may choose to have a fund that covers expenses for 12 months.

For example, let’s assume that Hanna’s household bills are $500 and the cost of food is $300.

She spends US$150 on health and US$50 on transportation.

To maintain her standard of living, she needs US$1,000.

Considering that she prefers to structure her 6-month emergency fund, she needs to save US$6,000.

Secondly, let’s think about the Jones family:

Household bills – US$2,000;
Food costs – US$700;
US$600 for health;
US$400 for transportation;
Leisure – US$300.

The average cost is US$4,000, and if the family wants to build an emergency fund that can cover expenses for 1 year, they need US$48,000.

In this case, it’s worth remembering the following:

If you’re going to make a fund for your family, you don’t have to save the money alone.

Your partner, a working child or even a retired relative who lives with you can help you structure the fund.

How to have a fund

Although it’s obvious, you should save.

Even if you can’t set aside US$1,000 every month to invest in your fund, you can always start small.

If you can only set aside US$100 every month, no problem!

We have content on financial goals and objectives.

If your goal is to have an emergency fund, you need to set small goals to meet your objective.

Let’s go back to Hanna’s example, assuming she can only save $100 a month.

With this as a priority in her life, every month she will set aside this money and do more:

Hanna is bilingual and when she was looking for ways to earn extra income, she came across the possibility of working in translation.

Although it’s tiring, she gets started and manages to make an extra $400.

By staying consistent, in just one year, Hanna manages to build up her emergency fund.

One thing’s for sure, if you don’t save at least a little, you won’t have any.

So at least get started!

Secondly, make a budget.

In both Hanna’s example and the Jones family’s example, we talked about all the expenses and their respective prices.

Find out exactly how much you spend on rent, food, transport, condominiums and rent payments.

From your budget, you’ll know how much you need to save in order to have your emergency fund.

Pay yourself first and forget about the fund

Next, use the strategy of paying yourself first.

Although it sounds strange, it’s effective.

Why do you keep waiting until the end of the month to save, hoping that miraculously you’ll have money to put in your fund?

It’s time to pay yourself first by saving as soon as your salary hits the bank.

Treat the fund as an expense that must be paid monthly.

Otherwise, you’ll log into your bank account, see the money there and think it’s available to be used.

And of course, here’s an essential tip:

Forget the fund exists.

We’ll talk about when it’s the right time to use your emergency fund later, because it’s a mistake to think that this is extra money to buy a product you’ve always dreamed of, for example.

While you’re saving, set the money aside and forget it exists.

Only remember it at a critical moment.

Take priority and think about investing

On the other hand, think about priorities.

You may need to spend a whole year spending as little as possible to structure your fund.

You should do this while the people around you change their cars, their cell phones, their houses, while they buy products you wanted to buy or travel to the place of your dreams.

When you learn to prioritize, you start looking at yourself and stop looking at others.

Also, make sure your spending is in line with your goals and objectives.

If you want to have an emergency fund, as well as buy a house, do your monthly expenses reflect this?

If you don’t prioritize, your spending will jeopardize your plans. So be careful!

Finally, always think about investing the money you save over time.

Today, there’s no point in taking the money you save and putting it under the mattress or leaving it in a current account without any income.

With time and inflation, you will destroy your finances and lose your purchasing power.

Therefore, an essential step is to invest to guarantee some income, however little.

Where to invest your emergency fund

To ensure that your money is protected and available at any time, you can choose to put it in a money market account.

You can also put the money in a high-yield savings account or CD.

Let’s consider each of these options below, so that you can decide which is best for you.

Money market account

This type of account earns interest at banks or credit unions.

They are therefore a kind of current account and savings account.

It’s interesting to have an emergency fund because it’s considered a low-risk account.

It’s also worth noting that this type of account provides APYs of around 3% to 4% and most are insured by the National Credit Union Association (NCUA) or the Federal Deposit Insurance Corporation (FDIC).

This means that your money will be protected up to $250,000 per account.

There are different banks that give you access to this type of account, which includes other features such as a debit card and/or check writing.

In this sense, you have instant access to your funds.

And depending on the account, you may be able to make a certain number of free withdrawals per month.

High-yield savings account

This type of account is usually offered by online banks.

It’s also a good alternative for providing you with returns while keeping your emergency fund safe.

As such, the interest rates are higher than traditional savings accounts.

Because of this, you earn 3% to 4% with many high-yield savings accounts, compared to an average APY of about 0.3% from traditional savings accounts, according to the FDIC.

The money is usually insured by the FDIC and can be accessed by transferring funds over the Internet.

In addition, you can make an outgoing wire transfer, check request or telephone transfer.

However, since the account is offered by an online bank, you won’t have access to the funds at a branch.

Option for investing emergency funds – Certificates of Deposit (CDs)

This is also an alternative because your money yields more when compared to the idea of leaving it in a checking account.

Like money market and high-yield savings accounts, a CD offers FDIC protection.

There are CD options with longer maturities, such as 5 years.

In this case, the interest rates are higher and at the end of the term, your money earns more.

However, if you need to withdraw the money early, you will have to pay a penalty.

That’s why it’s not 100% suitable for a fund, as it’s difficult to access the money quickly.

To put it simply, the early withdrawal penalty on a 5-year CD could be 6 months’ interest.

So if you withdraw the money 6 months, the bank will deduct the penalty from your principal amount.

In other words, part of your emergency fund is lost.

We’re talking about this here so that you have more options.

Financial advisors recommend that you keep 3 to 6 months of cash expenses in highly liquid assets to use in times of emergency.

In the case of the Jones family, for example, you can have a money market or high-yield savings account, in which money equivalent to 6 months is invested.

This way, part of the emergency fund can be accessed at any time.

And the remaining money can be used to buy CDs, so that access is more restricted, but the yield is higher.

What qualifies as an emergency?

Finally, let’s talk about when you should use your emergency fund.

This is an important subject because you must learn to differentiate between consumer wants and needs.

Having money saved can be a temptation for many people, but here are some examples of when money can be used:

If an individual uses his car every day to go to work in another city and if that car is stolen, the fund can be activated.

This is a real need, but consider:

A person uses their car only for leisure and wants to exchange it for a newer model.

This is just a desire, not a need.

Another example where the emergency fund could be used would be for health problems.

If you or a family member don’t have medical insurance or the insurance doesn’t cover the type of illness they have, the fund could help with treatment.

On the other hand, imagine that a pipe burst in your house, there is a problem with the wiring or a tree fell on the roof on a rainy day.

These are emergencies in which the money in the fund can also be used.

What if the fridge stops working?

Problems with essential household appliances should also be considered emergencies.

And, of course, we should also talk about last-minute trips.

We’re not talking about leisure trips that need to be planned in advance, but rather emergency trips such as when a relative is ill.

This type of trip is often very expensive, so it’s worth using the fund to cover the expenses.

Importance of insurance and final tips for using your emergency fund

In conclusion, we’d like you to note the following:

Emergencies do happen, but it is possible to prepare in advance, while not using the fund.

For example, if you have home insurance or car insurance, you don’t need to withdraw money from the fund if a tree falls on your roof or your car is stolen.

So, as well as worrying about building up your fund, worry about taking out other services that guarantee your protection.

And remember:

There’s no point in making every effort to spend the money in your emergency fund at the first opportunity that arises.

Use the money wisely and in times of crisis.

Daniel 25 de March de 2024

Finance