Everything You Need to Know About Building an Emergency Fund

When people talk about rainy day money, they are often describing the funds they have for if something goes awry. Perhaps there is a leak in the bathroom and they need to get a plumber in to fix it, or maybe they are exhausted and want to book a holiday in the sun to relax and destress. This is a good budget to have and if you can, having this kind of savings will improve your lifestyle no end.

However, a rainy day fund should not be confused with an emergency fund. An emergency fund is a pot of money that you keep safe, not touching it at all until you absolutely have to. Think of this money as your safety net, ready to catch you should you fall.

There are plenty of articles online that have very different opinions about emergency funds. There is a lot of debate about how much money should be stored away and determining what an emergency is can be a very personal opinion. This article, then, is about trying to figure out where the pros and cons are, and how to navigate them so that your emergency fund works for you.

How Much Should I Save?

Deciding how much to save is a difficult question for two reasons: first, the money you are putting away is not going to work as hard as your invested monies and so it is, in effect, a dormant fund; second, only you can decide how big an emergency you are likely to face and know what will make you feel more comfortable.

To tackle the first issue, you should begin by looking at your portfolio as a whole. Creating a balanced portfolio is an important factor in looking after your money. This means that you should have some money in stocks and shares, some money in savings accounts and some money in safer investments like bonds or property. By balancing your portfolio, you will have some high risk investments, some low risk investments and some money that isn’t invested at all.

As your emergency fund will be a savings pot, you need to balance the amount with your risk. If you are taking lots of high risks, you should probably have more in savings to mitigate the risk in terms of potential losses.

What Qualifies as an Emergency?

Determining what an emergency is will also affect the amount of money you choose to keep in your emergency fund. For example, many people choose to save around 3 months wages in their emergency fund because the most likely reason for them to dip into the money is the potential for being made redundant. Or, you might consider how much it would cost if you were to be injured and add up things like the cost of an accident lawyer, the time you would need off and any surgery you may end up paying for.

In essence, the answer to this question is a case of figuring out the likelihood of something happening and then the cost of that event. This is exactly how an insurance company estimates costs for insurance policies and is a good way for you to quite literally self insure with your savings. It is worth saying now, though, that even with a sizeable emergency fund, buying an insurance premium is still one of the best ways to mitigate the cost of a disaster.

How Should I Build My Emergency Fund?

If you don’t currently have any savings, building your emergency fund is the first thing you should do. As with all good things, there are a few ways that you can go about starting to build your fund: making regular deposits to a savings account, transferring money from investments or saving any windfall that comes your way. Each method has its benefits, but let’s run through them one by one to get a better view.

Regular Deposits

This is the slowest but surest way of building up your emergency fund. Think about how much you can spare from your monthly budget and set a realistic amount to put into savings. Normally, this is between 10 to 20% of your income, depending on your other financial commitments. If you are also investing, this number may be a little smaller.

The larger the deposit you can make each month, the faster it will grow, but the most important thing is that you are able to make each payment without being too uncomfortable. Once you have reached the amount you have decided upon, you can scale back or completely stop making deposits into this account.

Moving Money Out of Investments

Investing money is the best way to make it work for you, so you should think carefully before you do this. If the investment is quite easy to liquidate then it might be more worthwhile to let it mature and then sell in due course instead. In this sense, you are using an investment as an emergency fund, rather than having a set account of savings. While you are still risking losing everything, a low-risk investment can work quite well, especially if you are making money on it.

Saving Windfalls

A windfall is an amount of money that is unexpected or surplus to your usual income like a cheque on your birthday or money from a side hustle you might have picked up. Saving this money is always a good idea and if you can put it towards your emergency fund, you will see it grow. However, if this is your only method for growing your emergency fund, you won’t have a specific end date in mind and may never manage to save your set amount.

However much you choose to put into your emergency fund, and whatever you choose to designate an emergency, putting money aside for this purpose in any way possible is always better than not saving at all. Even if you can only manage a tiny proportion of your income each month, it is worth making the effort to do so to financially cushion you in the future.

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