How to Start and Determine the Right Size of Your Emergency Fund

by Jennifer Richardson

Sometimes you only realise the true value of a concept like an emergency fund when you don’t have one.

The topic of emergency funds is never more prominent than when a financial crisis is around the corner.

We don’t often think about worst-case scenarios until it’s too late.

It is sobering to learn how many people ‘live on the edge’ and are days away from a potential life disaster.

Without the right size of emergency fund, how long could you last if you lost your job today or a health crisis hit the family?

What is An Emergency Fund?

As the name describes, an emergency fund is a store of easily accessible money that you have saved or assigned to cover unforeseen events or emergencies.

Now that doesn’t sound too complicated.

But it seems many people don’t have a safety net for themselves or their families – they have no savings or emergency fund to call upon when the tough times hit.

The rising cost of living is increasing the pressure on people and their budgets. They are often only one disaster away from potential ruin.

And it is not a matter of people wildly spending causing the problem. Yet, many face the prospect of future life upheaval due to a lack of financial options.

A quick search online reveals the following worldwide savings statistics –

US

• Over one-third of Americans have more credit card debt than savings
• 68% per cent of people surveyed could not last more than a month if they lost their job 
• People with jobs were the worst affected

(Source – Bankrate)

UK

• A survey suggests that a quarter of UK adults have less than £100 set aside in savings, leaving them vulnerable to rising and unexpected bills.

(Source – BBC)

India

• At least 75% of Indians do not have an emergency fund and could default on their EMIs in case of a sudden job lay-off  
• Indians consider their parents or friends as an emergency fund
• One out of four Indians cannot even last a month if they lose their income

(Source – Times of India)

Canada

• One in four Canadians cannot cover an unexpected expense of $500. 

(Source – Statistics Canada)

Even more sobering – 1.7 billion people worldwide do not have a bank account at all!

Why do we need an Emergency Fund?

I had just moved house and lost my job when the Global Finance Crisis (GFC) hit in 2008.

Even though I considered myself a ‘saver,’ and good with money, I had never heard of the term “emergency fund.”

Jobs were hard to find, the sentiment in the community was low, people panicked and withdrew cash from the bank, and consumer spending stalled.

Some people lost everything they owned and were left sleeping in cars, tent cities or friends’ sofas.

This is precisely the type of “emergency” scenario few saw coming. 

People who did not have an emergency fund were stuck trying other methods – selling possessions, getting a second job, or securing credit. 

But this all proved challenging in a Global Financial “disaster” environment.

And just when people made it through (some, not all), there was a second wave of financial trouble in many countries in 2011.

The GFC was a world-scale disaster. But what about more common, personal events?

For example, how would you deal with the following –

• Sudden loss of job
• Medical costs
• Home repairs
• Car repairs
• Vet bills
• School fees
• Increased taxes
• Increased Insurance
• Accident or injury
• Extreme weather events- Flood, fires, hail, tornado etc
• Legal proceedings

We have all watched the news in horror as people living in wildfires or other areas prone to natural disasters talk about letting their insurance coverage lapse. 

What would you do if you faced a large-scale economic loss? 

A credit card won’t cover such a huge financial disaster. Credit cards are a necessity for many people, but unfortunately there comes a time when they need to be paid back.

A credit card is not an ideal emergency fund. The interest is high, and it’s essentially not your money. 

You will be in debt from your emergency rather than staying afloat and using your own funds.

An emergency fund can not only help you in an emergency. It can offer more benefits such as –

• A feeling of safety, security and peace of mind
• Allows you the freedom to swap jobs with less pressure
• Less stress when a disaster or emergency arises
• Ability to help friends or family
• More control and choice in life decisions

Size of Emergency Fund – How much is really enough?

The general rule that most finance experts quote for the size of an adequate emergency fund is three to six months times your monthly costs.

So, you must ask yourself, “How long can I last without income?”

This will be different for everybody, even those with the same income!

Expenses will vary; you may or may not have a family as backup, or perhaps you live in a remote area where jobs take longer to secure, etc.

All this plays into the size of the emergency fund that will save you when you need it.

It’s important to remember that you may not be able to rely on credit during a worldwide or country financial incident. Credit is often the first thing to dry up, and no one wants to lend during times of mass job losses.

If it’s a personal emergency and only affects you, or a small group of people, then credit may be available to see you through.

So it’s a prudent life and financial decision to try and assemble your cash pile for that inevitable rainy day.

It is here where you need a very good handle on your expenses. Also check out these 9 ways to Save money.

You might think you know what they are, but it’s easy to be wrong. Many people make the mistake of adding up just the “big” monthly costs (house loans, rent, car payments, utility bills) and fail to accurately add up the “miscellaneous” expenses.

This failure to accurately understand your expenses can lead to an inadequate emergency fund. It may run out in two months instead of four.

It’s easy to underestimate expenses when you do not track them (think of it like a food diary – you think you remember what you ate yesterday, but if you don’t write it down, you can easily forget the four cups of coffee and small snacks etc.).

The same happens with tracking expenses. The only way to really work out your emergency fund size is to track it diligently.

Things that can be missed are occasional or annual expenses like –

• Haircuts/grooming
• Seasonal costs
• Medical or dental visits
• Infrequent or annual home or car maintenance costs
• Subscriptions & Memberships
• School/educations costs
• Pet care
• Entertainment
• Insurance
• Gifts

The size of your emergency fund needs to be based on actual figures to the best of your ability. You can be wildly out otherwise and miscalculate your ideal amount.

Prioritising your Money

It’s very unsexy to plan for unforeseen events. It’s better to enjoy your life now and have a vacation, right?

Well, what is really unsexy is becoming helpless after an unplanned crisis and losing everything you have! 

It may seem unlikely, but it happens every hour of daily unforeseen health diagnoses, job loss, relationship breakdowns, family crises, natural disasters, and “random” freak events. Here are 10 invaluable life skills that stand as your support system when confronted with such challenges.

An emergency fund will hopefully stop you from constant worrying and fear and let you live your life with a little freedom and confidence.

If you do not have excess funds to put into an emergency fund, it may mean re-prioritising your spending.

Perhaps you do not go on another vacation until your emergency fund has been filled?

You might have to delay purchases in order to re-direct the funds to your safety net.

It’s a challenge for many people to balance their needs. If you often find it hard to manage your finances, there could be some hidden reasons behind it.

You are putting your money aside for something that may not happen afterall. But if it does, you will be in good shape.

It takes a serious commitment to delay gratification or go without something for enough time to build your fund.

Only you can decide what means more to you. 

A way to save and enjoy life might be a good comprise that the whole family can swallow – a shorter vacation? A cheaper new appliance instead the top-of-the-range?

How to Start Building an Emergency Fund?

This is really the main question that faces many people who cannot save any money after paying their bills each month.

They often have no room to move and are doing their best to stay afloat.

For those with a little spare money, starting can mean budgeting a set amount each week or month that they can afford to keep separately and not use.

It may require sacrificing a lifestyle choice or re-arranging another aspect of your life to find the spare money.

Now, where to keep emergency fund?

To securely keep your emergency fund, it’s a wise move to establish a dedicated savings account. Those with adequate income compared to expenses can set up an automated deduction on their primary bank account into an “emergency fund” account.

Savings Tips that you should know

• Track every expense for at least two months. Use our free tracker sheet to do so.
• Re-arrange lifestyle if required (cheaper rent, stop impulse purchasing etc.)
• Investigate the possibility of working in an additional income source (at least until you build your emergency fund)
• Stay with family or friends if that is an option
• Look for deals and enjoy more affordable entertainment, meals, vacations etc.
• Delay spending and purchases on non-essential items
• Cancel unused subscriptions or memberships
• Refinance where possible to lower interest rates or better payment terms
• Research more affordable insurance cover (only if that is appropriate for your situation, i.e., don’t let natural disaster cover lapse if you live in a disaster zone!).

Summary

The value of an emergency fund is unquestionable, so it’s down to the question of what size should yours be?

Only you can determine the amount based on real-life expense tracking and assessing things like the probability of finding new work, recovery time from serious illness, etc.

The key is to make an emergency fund a priority in your life. It may only take a few months or it might be years, but when disaster strikes, you will be forever grateful you made an effort.