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However, if you don’t have a very large financial margin, it is expected that you will find building your emergency fund an impossible task. However, know that there are several ways to build this type of savings, which can be done in the long term. While it is inevitable to have to make some sacrifices , an emergency fund will guarantee you greater financial stability and freedom in the future.
That said, in this article, we explain what this savings is and put together some tips to build your emergency fund.
What is an emergency fund?
Its name says almost everything. However, the concept of an emergency fund is broader than savings that cover emergencies and contingencies. However, this is your base. An emergency fund is intended to help you deal with emergencies and unforeseen events without compromising your family budget.
When it comes to contingencies and emergencies, expenses/charges that are essential to your life are included, such as health expenses, the arrangement/purchase of an essential item for your day-to-day life, for example a refrigerator, or even the repair of a fault in your your car that your budget can’t afford. However, the emergency fund has another, even more relevant purpose. That of guaranteeing their subsistence or quality of life in the face of an unexpected situation of unemployment or a drop in income.
One of the main doubts about this savings account is its value. In fact, there is no ideal value that suits everyone, as it depends on the burdens and reality of each household. But one thing is for sure, the greater the value of your emergency fund, the more financial stability you will have throughout your life.
However, you need to set goals when building your emergency fund. And taking this into account, it is advisable that at the very least, your fund covers between 6 to 12 months of the total amount of your essential monthly expenses.
However, we are talking about minimum values. Ideally, this savings will allow you to be completely relaxed in a situation of involuntary unemployment, since depending on your profession and age, it may take more than 12 months to find a new job. But, as a rule, having a fund that covers 1 year of your essential expenses is a pretty safe scenario.
Finally, the last point to note is that if you have an emergency fund, your need to resort to credit cards or other types of personal credit is drastically reduced . And this is a very important point. If you manage to be your own bank, you avoid the risk of aggravating your financial situation, of getting into debt and never having to pay interest . When it comes to replenishing the money you use from your fund, you can do so in as many installments as you wish without any type of penalty.
10 Tips For Building Your Emergency Fund
1. Identify your essential expenses
Just as a house is not built by the roof, an emergency fund cannot be built without first identifying all its essential expenses. And this is a task that can take more or less work. If you have a family budget where you have all your expenses and income recorded and updated , this is a simple task. But if you don’t, you’ll have to collect all your essential expenses.
And what expenses are these? It all depends on your family and your own needs. But there are essential expenses that are unavoidable for all of us, such as the bill for water, electricity, gas, housing credit installments or rent, loan installments, insurance, food, taxes, transport, education, among others.
Out of essential expenses, spending on meals out, night out, impulse purchases should be left out. After all, at this moment what you are trying to determine is the essential value to cover all your family’s basic needs. Of course, if your financial situation is quite stable, you can add a fixed or variable amount to the amount of essential expenses that covers other non-essential expenses. In this way, you will also ensure that you do not lose quality of life during the months that you need to draw on your emergency fund.
But to start, focus only on essential expenses. Do a survey of all invoices and take a good look at your bank statement. Identify those annual charges and finally divide the amount by the 6 or 12 months you want your fund to cover.
To help you with these calculations, let’s assume that your household has a value of essential expenses of 1000 euros. If you want to create a fund that covers these charges for six months, you need to raise 6000 euros. If your goal is 12 months, then your fund should consist of 12,000 euros.
2. Set the time needed to build your emergency fund
Defining how long it will take to build your emergency fund is probably one of the most important points to consider. After all, if you need to gather between 6,000 and 12,000 euros, the first thought is that it will be very difficult to collect that amount, especially if your budget is already tight.
But the big difference in achieving this goal or not is the strategy you implement to reach the final value you need. For some people , putting 200 euros aside is not a high financial effort. In these cases, in one year the household manages to collect 2400 euros. In 2 and a half years, the emergency fund would have 6,000 euros and in 5 years 12,000 euros.
In a family where there is the possibility of saving half of that amount , it would be logical that the emergency fund of 12,000 euros would be reached in 10 years and that of 6,000 euros in 5 years. But this doesn’t have to be a sure account. After all, if you work for someone else, it is normal for you to receive a Christmas subsidy and a holiday subsidy, and you may be entitled to receive a refund amount from your IRS.
If you take a slice of each of these incomes that results in an annual amount of 500 euros , you would reach the goal of 6,000 euros in less than three and a half years.
The following calculation is used:
- (100×12) + 500 = 1700 euros
- 1700 euros x 3.6 = 6,120 euros
That is, it is important that you set a time goal and define values that allow you to build your emergency fund without putting your family budget at risk . Even if you don’t have these monthly amounts to save, it’s better to put 30 euros aside every month and reinforce this amount whenever possible. It is logical that the path will be longer to achieve this goal.
For example, 30 x 12 is 360 euros in one year. If you add 500 euros to this value every year, which may result from subsidies or other income), you add 860 euros annually. In this situation, you need seven years to reach an emergency fund of 6020 euros. But it may be shortening the timeline if your income increases. The most important thing is to focus on this goal and keep the commitment you made.
3. Is there money left over monthly? Direct it automatically
Saving is not always an easy task. And this sometimes happens for lack of method and not for lack of money. That is, there are families who manage to reach the end of the month with even a significant amount of savings. But if this money stays in the current account, it is more likely that it will end up being used for other purposes or objectives.
For those who manage their money through a family budget and have defined a percentage of their salary for savings , the way to build an emergency fund is quite simple. All you have to do is grab that amount destined for savings and program your transfer/debit at the beginning of each month to another bank account . This account must not have associated commissions, in order not to lose money. Here, commission-free savings or current accounts can be used. This is to avoid the risk of losing money.
If you don’t have this habit, it’s time to put it into practice. After surveying your essential expenses, drawing up a timeline and the monthly amount to put in this savings account, just transfer the amount as soon as you receive your salary. You can also schedule this transfer to an automatic savings account. Thus, it avoids reaching the end of the month and not having the necessary day to put in your fund.
4. Consider making small cuts and adjustments that make all the difference
If you’re looking at your bills and budget and can’t come to a conclusion on how you’re going to get a monthly amount for your emergency fund, don’t despair. In fact, many people need to create new financial slack to achieve this goal. And this doesn’t have to imply drastic changes in your life, but if you make certain cuts and adjustments you can reach the monthly amount you need.
For example, small cuts can save tens of euros in your monthly budget. And eating out is one of them. Assuming you drink coffee out twice a day (22 days a month) , with a daily cost of €1.40, and you have breakfast out for half the month, which is equivalent to a daily expense of four euros. In these simple accounts alone we are talking about a monthly expense of 30.80 euros on coffee plus 40 euros on breakfast out. That is, a total of 70.80 euros.
If you have lunch out twice a week, and lunch represents an average cost of 7 euros, you spend 56 euros per month on lunches (14 x 4). If you reduce this expense by half, you save 28 euros.
With these small cuts alone, you can save €98.80 a month. But these aren’t the only ways to increase your financial slack. You can save on going to the supermarket by opting for white labels on various products, sell what you no longer use in second-hand stores, review some subscriptions and even adjust certain contracts and services to your needs.
If you are determined to build your emergency fund, in most cases there are solutions to reduce your expenses so that you have some money left to apply to this savings. However, it is normal for these solutions to affect your lifestyle a little.
5. Need more financial break? Review contracts and policies
In the event that you are already in cost containment and are unable to obtain a financial break to build your emergency fund, it is advisable that you carry out an analysis of your contracts and insurance.
For example, if you have a mortgage contracted a few years ago, review the conditions of your contract. This is because it can have a very high spread for the value that banks currently practice, which is around 0.95% and 1%. However, there are banks that practice a spread of 0.85% in special situations.
With regard to mandatory home loan insurance (home loan life insurance and multi- risk insurance ), you should also ask for simulations from other insurers and ensure that you are enjoying the best market conditions. But pay attention to your contract . These two insurances can be associated with a bonus on your spread. In these cases, it is necessary to do calculations and see if the change of insurance to another insurer compensates the penalty that you will suffer for withdrawing the policies from the contract.
6. Create a separate account to build your emergency fund
Throughout the article it was mentioned that you should build your emergency fund in another bank account. But why is this such an important tip to create this savings? Because it’s a way to make sure you don’t mix up the money set aside for your monthly budget with the emergency fund. That is, if you separate these values, it is easier to manage your personal finances, always ensuring the value of your emergency fund.
Bearing in mind that this is a savings account that has a very specific objective, the money must be directed to an account without maintenance or annuity fees or with symbolic amounts in these fees. For example, there are savings accounts where you don’t pay commissions or fees for early redemption. However, do not put your money in a solution that does not allow access to this money in an emergency.
7. Emergency fund is not to be messed with (in most situations)
One of the biggest problems in building an emergency fund is mixing its purpose with certain unforeseen circumstances or needs. Imagine, I would like to buy a new mobile phone, not because yours is broken, but because it is a little outdated compared to the new models on the market. These types of somewhat consumerist impulses should be removed from your emergency fund . Focus only on needs, unforeseen events and emergencies that are essential to your life.
However, you also shouldn’t use your emergency fund to:
- Make investments: It may seem like trying to monetize that money. However, the emergency fund is intended to cover your expenses in emergency or unforeseen situations . If you apply your money to an investment, in addition to running the risk of losing it, you may be limited in terms of redemption. It is advisable to start investing your money only after you have built up your emergency fund. This is a time when you benefit from financial stability. And from there, the savings you make can be applied to investments with greater peace of mind.
- Lending money from your fund: Lending money to someone is always a touchy subject, especially if the request for help comes from someone very close to you. However, it is normal for several unforeseen events to happen throughout the year, such as medical expenses, unexpected breakdowns, among other situations. If you lend money from your fund to someone without the guarantee that the person will pay you back in a very short period of time, you run the risk of having to draw on your fund and not having the money you need.
8. Did you mess with your background? Reset the value as soon as possible
There are certain times in life when several unforeseen events and emergencies happen in a short period of time. And it is normal that you have to draw on your emergency fund to cover this type of charges. However, whenever you use this savings, you should try to restore the amount used as soon as possible. This is a way to ensure that you are not left helpless in future unforeseen events.
Unlike other savings that serve to achieve a specific goal, such as a down payment on a house, buying a car or a vacation, the emergency fund is a savings to keep throughout your life.
In other words, it is not enough to reach the proposed value. You need to ensure that this fund will cover unforeseen events from the beginning of your professional life until the end of your retirement. Therefore, you need to keep this goal in mind at all times. There are months that require more effort to replace the values that were withdrawn from savings . But there are also quieter months when you don’t need to direct money to this fund.
9. Keep track of the amount you are saving
Keeping track of how much is in your emergency fund is a way to keep you motivated to achieve that goal. After all, this is a goal that often requires some sacrifices. So, if you regularly access the account where you have your fund, seeing that the value is increasing and getting closer to the goal you set, you will feel motivated to reach your goal.
10. Update your fund whenever necessary and in line with inflation
There are several situations that require you to increase your emergency fund . And, as a rule, these are complicated times, where it is not always easy to find extra money to invest in this savings. Therefore, it is advisable to invest in your emergency fund whenever possible. So, if these situations happen , your level of stress and worry can drastically decrease, as your emergency fund has a significant value that allows you to obtain peace of mind in the face of various scenarios.
The situations we are talking about are, for example:
- Birth of a child;
- A future increase in a child’s school expenses;
- More unstable employment situation that may lead to dismissal in the future;
- Loss of income of a member of the household;
- Goods that are at the end of their life and need to be replaced;
- Increases in income or credit installments;
- House exchange (both in the acquisition and in the lease)
- A health problem that gets worse may require a high investment in recovery;
- The death of a family member;
- Among other situations.