How to set up an Emergency Fund

Why do you need to set up an emergency fund?

• As the name implies, it is your safety net and response plan for emergencies, either due to the loss of a job or an unexpectedly large bill. It ensures that whatever happens, you are prepared and can keep paying bills. Depending on where you live, access to help when your income is cut short is not always available and can be difficult. There is also a risk of regulations changing with new governments as well as bottlenecks in accessing these.

• Setting up an emergency fund gives you a bit more freedom and control. Having some savings to fall back on is great when you have to make very critical decisions. You will be more focused on achieving your goals rather than just surviving. For instance, if you are between jobs and have a bit to go on, you will be less desperate in choosing a job just for the money.

• It is one of the basic steps to financial freedom. Financial stability is crucial for everyone. Money can be one of the main sources of anxiety. Managing your personal finances well gives you peace of mind and better mental health. Achieving financial stability means you can move onto bigger goals like paying off your mortgage, gaining financial independence and retiring early, building wealth, raising capital for a business venture and lots more.

How to set up an emergency fund

I covered how to calculate the required amount to save in your emergency fund in my previous blog post. To recap, start with getting an estimate of your monthly expenditure. You will have this already if you have a budget. Then estimate between 3-6 month expenditure and start saving towards it. If saving towards  3-6 month expenditure seems daunting, start with an amount and work your way up to it.

Where should I save my emergency fund

Preferably in easy access savings accounts and not in notice accounts. However, this depends on individual circumstances. If you are in permanent employment with a good notice period, then a 3 months rolling notice account or fixed deposit might be a good option.

The important thing to note is that the purpose of this fund is not for investment, it is your safety net for emergencies so it needs to be accessible and liquid not tied up in assets or risk carrying investments with the possibility of losing your capital.

Saving your emergency fund in a different account to your regular day to day account is preferred to prevent you from dipping into it. I usually prefer not to test my discipline. However, if your regular account allows you to create a separate pot for goals whilst offering a better savings rate you can use it to save to the required level, then transfer it to the best easy access savings account you can find. It’s really up to you to decide how best to do this.

You might think leaving money in a savings account doesn’t make sense given that savings rates are usually lower than other classes of investment. This is because your emergency fund is your safety net and needs to be in a risk-free account.

What next?

If after reading the above you are still thinking: this all sounds great but, I am;

• Still struggling to cover my month to month expenditure
• Have debts
• Don’t have enough left to save after my monthly expenditure
• Have a little left to save but when I calculate my required emergency fund it is so big I don’t think I can save that much.
• Always have emergencies that eat into my emergency fund. It’s back to square one all the time
• Having a savings pot means that I will not have access to financial help
• Save and invest all I have left after my expenditure

If you have some of the questions above and more, then start with my first step to financial stability. Create a financial goal, e.g. to pay off debts, save in an emergency fund, save in a pension, buy a house, pay off a mortgage. In order to achieve your financial goals, you need to understand your expenditure and keep them below your income. To do this you will need a budget. I will be doing a budget series soon. So make sure you subscribe when the button pops up to get a reminder and link to 5 budget topics.