An emergency fund is defined by Investopedia.com as an account that you put aside to help you through the unexpected yet important financial needs that you will encounter in your life. Regardless of how careful you are in your life, there are certain things that you cannot avoid and given that, you need to be prepared always.
There is no saying what the future will bring and even the medical community believes that prevention is a lot better than cure. That is the same principle that can be used in your financial life. The only way that you can prevent a financial disaster is when you have enough savings that will tide you over in case something happens that compromises your budget.
It may sound like a cliche but your savings can literally save your life. If you have no plans for your future that requires you to put aside money for your savings, the very least that you can do is to make it secure.
There are three important considerations when you are building your emergency fund and we will discuss them one by one. It is not just about the accidents or sudden illness that you need to prepare for. When you understand the different aspects that requires a reserve fund, then you can feel more secure about your future.
Saving for the predictable annual expenses
Most budgets are created with a monthly time frame. This means you consider your monthly income and expenses and you stick to that. This is a great way to keep your budget flexible since our expenses encounter seasonal changes. However, we oftentimes concentrate on the month on month spending and we fail to consider the expenses that come only once a year. There are two categories that you need to save up for:
Annual fees and charges. These include our property taxes or those once a year membership fees and other charges that we have to pay for. If you do not prepare for these, it can ruin your budget once the bill for these annual costs come in – at least, the budget for the month when the payment is due.
Annual events, occasions. You should also consider the once a year expenses like birthday event, anniversary dinners and holiday gifts that you need to spend on. These can be controlled but you nevertheless have to know how much you can afford to use from your budget. In case something happens, you don’t have to worry about sacrificing these expenses.
Setting up a reserve fund for repairs and maintenance expenses
These are part of the unexpected costs that you have to spend on repairs and maintenance costs. You can put everything under one account or you can put it in separate car and home repair/maintenance funds. Your car breaking down is an immediate need that is not always a cheap expense. The same is true for your home’s heater or air condition unit. These can also include the replacement budget that you may want to spend on when your possessions have gone past their life expectancy.
The reason why you want to be prepared for these instances is because you cannot prolong the repair or replacement of your home/car without sacrificing the comfort of your family. Also, taking too long could worsen the condition of your possessions. Sometimes, to avoid this, we opt to borrow money to finance these needs. But if you already have the emergency fund ready, you can save yourself from borrowing and being indebted to someone else.
Preparing for emergency situations
Of course, your emergency fund should also be primarily used for the unexpected emergencies that may or may not happen. The first two expenses can actually be predicted and thus are not entirely unexpected. The factor that makes them a part of your emergency fund is the fact that you do not know when they will happen or how much you need to spend for each event. With an emergency, we are referring to job loss, a sickness, an accident or even a natural disaster. These are situations that are usually grave enough to change your lifestyle entirely. You need prepare for these by stashing an amount of money that can support your way of living for the next 8 months to a year even without a main source of income.
Admittedly, it can be difficult to set up all of these emergency funds but there are tools that can help you cope. The National Debt Relief website has a free budget planner that you can use to input the monthly amount that you have to set aside for your emergency fund. Also, monitoring can be done through online tools like Bankrate’s saving goals calculator. Search the Internet for other tools that you can use to help you grow your emergency fund.
Here is a video that we created to help you come up with a budget that compliments the type of lifestyle that you want to have.