In an ideal world, life goes on smoothly.
You wake up in the morning… go to work… and retire back at home at night. At the end of the month, you collect your pay check. You save some, spend some and then have fun along the way, though not necessarily in that order. Plus, you have a perfect job in a stable company and the Stock Market is always bullish.
You see trees of green. Red roses, too. What a wonderful world, right?
Unfortunately, if you wake up to reality, it’s not always that way. There are humps along the road. Accidents could happen. A typhoon could hit your place. Your house can burn down into pieces.
Are you prepared when any of these unexpected events strike? Do you know how to handle such situations?
It is for this financial bummer that you need an Emergency Fund. You will need this money in the event of illness, unemployment, or any emergency situation. When emergencies strike, a lot of good people become bad simply because they lack the emergency fund to cover the expenses caused by the event.
You don’t want to be the bad guy in emergency situations, do you?
Emergency Fund is not Savings Fund
It is important to distinguish the two kinds of funds.
Some people are saving money, usually in deposit account, in order to spend it someday. A new pair of shoes for the up-coming Christmas Party would be nice. An iPhone as a gift to one’s self during his birthday, that would cool. And saving up for the down payment of a new car, that kind of discipline is worth emulating.
However, you don’t use your Emergency Fund this way. No, no, no… an Emergency Fund is more sacred than that.
It’s best to think of this as your Touch-Me-Not Money. You just to touch no matter what happens. That is, until necessary.
(See also: Saving vs Investing — What’s the Difference?)
Tips on Setting Up An Emergency Fund
There’s really no hard and fast rules on how to go about this, but the following tips would be of great help.
Tip #1. Save at least 6 months worth of your income.
Charles Swab says ideally you should set aside 3 months worth of regular expenses for your emergency fund. When I decided to go freelancing, I saved up to 6 months of what I was earning as a regular employee. It was not that much, but it’s enough money to keep my confidence up the first time I tried the self-employment adventure. I never regretted doing this. I found out that most of my friends who became freelancers did not last more one year.
If you can save up to one year of your employment income in an Emergency Fund, go for it.
Question: “What if I have money that’s more than a year’s worth of salary, should I limit the Emergency Fund up to one year maximum?”
Answer: Hand me that money and I’ll show you how to save it. Just kidding. 🙂
Well, one year should be enough and any more amount in excess is better set aside for something else such as an investment or a business where it could grow even more.
Tip #2. Make it accessible and safe.
Put it in a place which you can quickly access and withdraw this money.
Commonsense dictates that it must be a safe place also. When I say safe, I don’t mean the dog house, where Browny and Blacky are always hiding. Not even under your mattress, though you always make sure you lock the bedroom door when you are out of the house.
In this Digital Age where money could be represented by a series of numbers reflected in a piece of plastic, the best place to kept your emergency money is still the bank. If you have access to the Internet, or the ATM machine, you can sleep soundly at night knowing that your money will still be there the next morning when you wake up and ready for you to take anytime.
Tip #3. Keep this money liquid.
There are many forms of assets: real estate, gold bars, jewelries, shares of stocks, bank deposits, etc. Liquidity refers to the convertibility of these assets to cash.
Gold bars, even if I have not yet seen one personally, I know these assets don’t constitute a good emergency fund. In an emergency sale, owners of gold, like real estate owners, are forced to unload their assets at a much lower price than its market value. Instead of making a profit, you are actually at a loss.
When it comes to liquidity, nothing beats a savings account in a bank.
A Money Market Mutual Fund could also be an alternative to a savings account, allowing your money to grow a little more, but you have to tie it to an ATM account so you don’t run the hassle when you redeem that your investment and turn it into cash for emergencies.
