Emergency funds explained
Whether it’s for unforeseen emergencies or unplanned expenses, an emergency fund can help you manage unexpected challenges and circumstances. Let’s have a look at the meaning of an emergency fund, the pros and cons, why you need one, and where to keep it.
What is an emergency fund?
An emergency fund, also known as a rainy day fund or contingency fund, is a dedicated savings account that covers unexpected financial emergencies. This fund is a safety net for unforeseen expenses such as household repairs, job loss, or unexpected bills like medical expenses. It’s important to build an emergency fund to make sure you have financial protection in times of need.
Why is it important to have an emergency fund?
If you’re employed and managing your monthly bills, it’s more likely that you will benefit from an emergency fund. Consider a situation where you suddenly lose your job or require urgent medical assistance. Regardless of the circumstances, you will have financial responsibilities to meet.
This is why you may benefit from an emergency fund. It’s a savings pot designed specifically for contingencies. For your own peace of mind, it’s better to secure your future with some cash set aside for any uncertainties and to avoid loans that might add to your debt.
These are some examples of situations where you might need to rely on a rainy day fund:
- Job loss
- Hospital or medical bills
- Vet expenses such as pet surgeries
- Home repairs
- Broken or lost electronics
- Car damage or lost vehicles
- Unexpected purchases
By saving for a rainy day, you can make sure you’re financially secure when times are tough. Instead of having to borrow money or take out a loan, you can dip into your emergency fund and mitigate a potential financial burden.
How much money should be in an emergency fund?
Financial experts often recommend having at least three to six months’ worth of living expenses or three months’ salary saved as your emergency fund. But, the right amount will vary based on individual factors, such as:
- Household expenses
- Family size and contributing members
- Job stability
- Cost of living in your city
If your total monthly household expenses, including rent or mortgage, total €1,500, and you’re following the three-month guidance, you should try to save at least €4,500 in your emergency fund.
For added security against financial burdens, some experts even recommend saving up to six months’ worth of costs. If your monthly expenses are €1,500, your contingency fund would have €9,000 for emergencies. This may seem like too big a number at first glance, but it is the upper limit on your emergency fund. As long as you have a sum of money, however big or small, set aside, it will help you in a crisis.
Pros and cons of emergency funds
At first, you may find it inconvenient to have an emergency fund as it ties up your money for a period of time. But, at the same time, it also means that you’re well-prepared in case of financial instability. We’ve listed some pros and cons to help you make a decision on building an emergency fund.
Advantages of emergency funds | Disadvantages of emergency funds |
|---|---|
You won’t need to borrow money or make difficult financial decisions | You’ll need to save a set amount of money each month |
You’ll avoid the stress and panic of trying to find money in an emergency | You’ll need to choose a savings account that allows you instant access to your cash, and these types of accounts may not typically offer the most competitive interest rates |
If you exceed the six months’ outgoings target, you’ll have a small amount that you can choose to save or spend | |
In the unfortunate event that you lose your job, you can concentrate on finding a new job without having to rush into something just to pay the bills |
How to save for an emergency fund
The best way to save for an emergency fund is to start with what you can manage at the time. Calculate your average expenses over the past few months to determine a realistic savings goal. Afterwards, you can create a budget planner to see how much money you can save per month.
Here are some tips on how to create an emergency fund:
Budget wisely
Take time to review your expenses and cut back where possible. The best way is to budget wisely and decide how much you can save each month. If you’re saving three-months’ worth in your emergency fund, you can divide up your costs and set a goal to save as much as three times your monthly expenses. This can simply act as a guidepost for you to start saving, regardless of the amount. Another efficient way is to gradually increase your savings until you reach your target amount.
Start saving
Once the amount you need to save is accounted for in your monthly budget, it’s time to start setting it aside. Having a target date and milestones can be motivating.
Consider opening a separate savings account just for your emergency fund. This keeps any motivation to spend the money in check and may even earn you some interest. Make sure the account allows instant access to your cash in emergencies.
To simplify the process, you may set up a standing order from your main account to your emergency fund on your payday. This reduces the risk of spending the money before saving it and makes it a regular budget item.
For more, check out our tips on how to save money to grow your rainy day fund.
Avoid untimely use of the emergency fund
It’s hard to resist temptation, especially when you know you have money lying around. Make sure to only use the emergency fund for emergencies to maintain its purpose. Try to avoid using the fund for other expenses like holidays or shopping, to protect your future.
Replenish your emergency fund
If you’ve had a situation that required you to dip into the emergency fund, make sure to top it up to maintain your target amount afterwards. There may be more than one emergency in the future. In such cases, replenishing your emergency fund to keep the balance may be good financial planning.
Review and adjust your emergency fund
Periodically assess your emergency fund to adjust its size as your financial situation evolves. You may decide to add less or more per month according to your budget. Reviewing your emergency fund regularly can help you stay on top of your finances.
Where should I keep my emergency fund?
Once you’ve laid out a savings strategy for your emergency fund, the next step is choosing where to keep your money. A flexible savings account is typically the best option. Keeping large amounts of cash at home, under the mattress, for instance, can be a bad habit for your financial security.
When choosing the right savings account for your emergency fund, these are some tips to keep in mind:
Instant access: An emergency fund should be readily accessible in case of an urgent financial need.
Interest is not a priority: While earning interest is beneficial, it’s not the primary goal of an emergency fund.
DGS protection: Ensure your emergency fund is protected by the Deposit Guarantee Scheme to safeguard your savings.
Separate account: Consider having your emergency fund in an account separate from your daily banking to avoid spending it on everyday needs.
Considering all these factors, a demand deposit account is a smart choice for your emergency fund. It provides a secure place to keep your money while ensuring you can quickly access it when needed in emergencies.