In times of unexpected financial problems, you may have wished that you had a little more cash tucked away someplace. Anything from a sudden illness to a lost phone, a flooded house, or even a car accident can derail your cash flow and mess up your budget.
Regardless of the amount, such unplanned expenses seem to crop up at the worst possible moments.
Setting up an emergency fund is a surefire way of protecting yourself, and all you have to do is redirect some money to the account. By setting aside funds for any unanticipated costs, you will be able to bounce back quickly and continue working towards achieving your broader financial goals.
What Is an Emergency Fund?
An emergency fund, also called a rainy-day fund, is money put aside for unexpected costs. It serves primarily as a safety net in a financial emergency such as an illness, sudden unemployment, or even a pandemic like COVID-19.
It can be used for any unplanned expense, no matter how big or small, that was not accounted for in your budget. It should not be considered savings but a safety net for tough times.
If life has taught us anything, especially after COVID-19, it is that we must be prepared for anything. You must have your emergency fund ready to safeguard your future.
Why Do I Need an Emergency Fund?
An emergency fund is an important part of your financial security. Without a rainy-day fund or any savings, a financial emergency, no matter how small, could have you struggling to keep up with your goals and potentially lead you into debt.
An emergency fund is important and will help you avoid stressful situations such as
- Job loss
- Urgent medical procedures
- Emergency home repair
- Unforeseen auto repair
- Sudden death or disability in the family
Emergency funds are important as they help in the following.
Help you keep off debt
If an unbudgeted emergency occurs, you will be forced to take up loans or empty your savings account, leaving you vulnerable. However, an emergency fund accounts for that, and you can utilize it to navigate such demanding events.
It enables you to budget.
Unfortunately, it is impossible to include every tiny detail while budgeting. Sometimes you may leave out some essential things that need to be budgeted.
The emergency fund gives you a cushion to absorb unplanned costs before you can include them in your next budget.
Gives you peace of mind.
You don’t have to constantly worry about the “what if’s” of life. Knowing that you have some funds to deal with unexpected events is one less thing to worry about when you have an emergency fund.
How Much Should I Save for an Emergency Fund?
The amount needed for an emergency fund varies depending on a few factors. These variables include age, lifestyle, monthly costs, financial capabilities, prior commitments, level of debt, whether or not one has kids, etc.
The recommended minimum amount for a typical emergency fund should have at least 3-6 months’ worth of living expenses. However, due to the recent pandemic, some experts have suggested that one should increase that to at least a year’s worth of living costs.
Start by considering how much your regular expenses add up to and how long it would take you to bounce back from an unexpected job loss. Also, consider the arising expenses, such as medical expenses and car repairs.
Then think about how much money will give you peace of mind. If you prefer to put in a little more, feel free to do so.
It may seem like a lot of money initially, but if you set aside a certain amount each month, you will eventually reach your goal. Use our emergency calculator to see how much you need to save.
How Do I Build My Emergency Fund?
It may seem daunting, but it doesn’t take much to build an emergency fund. There are a few strategies that one can apply to get the ball rolling, whether you are living paycheck to paycheck or have a well-paying job.
Set a saving goal.
In this case, your goal should be to fund your emergency fund account.
No matter the amount you choose to put aside for your fund, make sure that you have a consistent money-saving habit. This ensures that you are protecting yourself from future mishaps. Once you set your goal, nothing can stop you.
Calculate the amount needed.
If your monthly expenses total Ksh25,000, multiply that by 3-6 months to determine the amount required in your emergency fund account.
If you cannot put the money aside in a lump sum, you can do it in monthly installments. You must calculate how much you need to save and devise a timeline.
If your emergency fund totals up to 150 000, you can decide to save for 6 months. This means 25000 shillings per month.
You can then automatically send the amount to your account, thus making it easier for you.
Start and automate savings.
Making a goal is a nice initiative, but if you don’t act on it, it is futile. To start saving for your emergency fund, create a separate account for it. Examine the accounts on the market and select one that allows you to access your money while also earning you interest.
Based on your goals, decide how much you will contribute towards the account and act on it. If you are forgetful, set up an automated request where the bank transfers the funds from the said account to your emergency fund account every month.
Assess and adjust.
Every few months, check on your account and act accordingly. If you have used up some of the money, devise a way to replenish that amount. If you have had a salary increase, assess and add on to your monthly contributions.
If you have achieved the six-month mark, you can consider adding any additional income to make up for more months.
Where Should I Put My Emergency Fund?
Depending on your financial situation and your financial abilities, your emergency fund should be easily accessible and safe.
You can try putting it in a money market fund, savings account, or savings account, depending on your preference.
A Money Market Mutual Fund
This is whereby money is accumulated from the public and the fund manager invest in different financial instruments.
This option offers :
Liquidity: You can withdraw your funds quickly.
Flexibility: you can transfer money to another account.
Security: your money is relatively safe as they do not invest in high-risk gambles.
Competitive Returns: Interest is calculated regularly and deposited each month. Therefore, you will benefit from interest if you deposit larger sums of money.
You can also save your money long-term.
They accrue interest; that way, you get to earn money while saving money. Most MMFs in Kenya offer 7–10% interest.
A savings accounts
Pick one that yields relatively high interest and one that is easily accessible. It has limitations on when you can withdraw your funds and, therefore, will keep you in check on not withdrawing when it’s not an actual emergency.
They accrue interest; hence, you will be saving and earning money simultaneously. You also have easy access to the money, which is in a relatively safe account.
When Should I Use My Emergency Fund?
You may be tempted to withdraw the money for your next vacation to Diani with your friends, to settle that Mshwari debt, to buy the latest phone, or even to cover your mortgage, but resist that urge.
To ensure that you do not use the funds for cases that aren’t actual emergencies, make a list of acceptable emergencies. They may include unemployment, natural disasters, cases of unexpected illnesses, or even unforeseen repairs to your car.
If anything is not on the list, you should not withdraw the money for that purpose. It will help keep you on your toes.
Final thoughts
An emergency fund is a great way to prepare for the unexpected financially. By setting aside money each month, you can build a cushion to help you cover unexpected expenses in a medical emergency, unemployment, or other unforeseen circumstances.
While it takes discipline to save up for an emergency fund, it is satisfying to have the peace of mind of knowing that you are prepared for whatever life may throw your way.