Conventional wisdom has always been clear when it comes to emergency funds. If you want to be financially secure or free, you have to start building your emergency funds now. Irrespective of whether you have a mountain of debt to pay or you’re barely making enough money to get by, saving for the rainy day is crucial to your financial journey toward a debt-free lifestyle.
What is an emergency fund?
But what exactly is an emergency fund? As its name suggests, an emergency fund is money set aside for emergencies. Maybe your car broke down unexpectedly and needs to be repaired immediately. Maybe you need to pay for a hefty medical bill. Maybe you lost your job and you can’t find a job soon enough. These are situations you don’t really expect but needs to prepare for. By building an emergency fund, you are essentially emergency-proofing your finances from unexpected expenses.
How much do you need to save?
There is no rule of thumb to the amount of emergency fund you need to save but as a guide, most experts recommend that you need an emergency fund that equals to at least 6 months worth of your expenses. Let’s say your monthly expense is £450 per month. If you want to build an emergency fund, then the goal is to save £2,700 in total. That’s money you should be able to access immediately in case of emergencies.
Where do you put the money?
Because emergency funds should be easily accessible, experts recommend that you park your money on a savings account so you can always withdraw it immediately when needed. Other experts, however, might argue that when you do so, your money will be earning very minimal interest. In fact, the interest earned may be too low if you add inflation as part of the equation.
If you can find a savings account that offers a relatively higher interest, that’s a good place to store your money. But if you can find other financial accounts that offer even higher interest, it’s worth checking out provided that the amount is easy to liquidate.
Do you save or pay your debt first?
Another argument some experts point out when talking about emergency funds is high interest debt. When you have a high interest debt, do you pay for the debt first or do you save up for an emergency fund?
Considering the low interest earned with savings accounts, it makes sense to pay your high interest debt first, right? Not exactly. This is where balance comes into play. Rather than focusing solely on paying your debt or saving for an emergency, you’d be better off strategizing your plan so you can do both.
Do you need an emergency fund?
To answer the premise of this guide, yes you need an emergency fund. While none of us wants an emergency, the fact remains that it can hit whether you like it or not. Rather than panic when it hits, you’d be better off being prepared whether it hits or not. By saving for an emergency fund, you’re protecting your finances and yourself from headaches in the future.
Once you’ve saved enough for an emergency fund, this is when you can use the money to eliminate your debt completely. Focus on paying debt with the highest interest first and go from there. Once you’ve fully paid off your debt, use the money to open another savings account but this time separate from your emergency fund. You can also use the money for investments such as stocks or mutual funds.