Over 40 years ago, Warren Buffet found a letter addressed to his aunt when he opened her safe deposit box.
The letter was from Warren’s grandfather, Ernest Buffet. Along with the letter, there was $1,000 in the safe.
Ernest wrote in that letter to her daughter-
“You might feel that this should be invested and bring you an income. Forget it — the mental satisfaction of having $1,000.00 laid away where you can put your hands on it, is worth more than what interest it might bring”
Why You Must Have An Emergency Fund
You may have been affected by a layoff recently or have experienced lower pay during COVID.
Or you could have experienced a small car experience, a home appliance damage or a loss of a cell phone.
You could even be in need of a sudden medical expense that you had to pay out of pocket.
Or maybe you didn’t budget for the holiday seasons.
Emergencies and unplanned expenses come in many forms and shapes. Even though they don’t always come with a hefty bill, even a minor fluctuation can set you back. These unplanned expenses often hit when you’re in a difficult financial situation.
There’s a way to get ahead of the situation- by managing an emergency fund.
What’s An Emergency Fund?
An emergency fund is a cash reserve that you set aside for financial emergencies or unplanned expenses. Unlike a sinking fund, this fund has no specific purpose attached to it.
Like a sinking fund, it can remove volatility from your personal budget. It can also create a safety net that’d both make you feel less stressed and more financially independent.
How to Build Your Emergency Fund
You can’t just wake up one day and store thousands of dollar as emergency fund.
If you have that much cash lying around, you probably don’t need an emergency fund to begin with.
You start building your fund by answering four questions
How much to save?
Your work starts with understanding how much you need to save.
To get an answer, look into your past and try to write down every emergency expense you’ve made in last 5 years. Then make an annual average.
Firstly, this will give you an idea about the type of experiences you can expect. You’ll also get a ballpark figure.
Additionally, you’ll be able to predict some expenses. For example, if you haven’t changed your phone in last 3 years, you might need to soon. Or if your laptop is 5 years old, it might be time to start saving for a new one.
If you can isolate those predictable expenses, you can create a sinking fund for them. That’ll allow you to keep the emergency fund for true emergencies.
Alternatively, you can target to save 3-6 months wort
How much can you save within a year?
Just because you have a number, doesn’t mean you have to get to that figure within next 3 months.
Keep in mind your expenses, sinking funds, investments and charities. And then allocate accordingly.
Emergency fund should go from your monthly savings. So, if you follow the golden rules of personal finance, your total savings (including emergency funds) should be within 10% of your monthly earnings.
How to save the amount?
One option is by setting aside cash.
But for any regular payments, it’s always better to automate the payment. Create standing orders so that money moves from your salary account to savings accounts or deposit schemes.
When to use the money?
For unplanned expenses, of course.
But it’s possible to wonder if the expense is the right one to take money from your fund. Or should you keep it in case a bigger emergency comes in.
You need to pre-define the categories and then just use the fund. Don’t leave this decision for later as you’d end up never using the fund.
Final Thoughts on Emergency Funds
Emergency funds will likely be unable to cover all your unplanned expenses.
However, it’ll still do two things-
- The fund will lower the amount of money during an emergency
- and it will save you from using your credit card during emergencies
Because if you don’t have an emergency fund, your credit card becomes it. And we all know how you can spiral into credit card debt from there.