Emergency Fund: Do I Need It And How Much Should Be In It?
Being prepared for the unexpected and your ability to cope with financial emergencies is a key to maintaining your personal finance wellbeing.
- By: Coins to Asset
- October 1, 2023
In This Article
Emergency Fund Statistics in Ireland
- 61% of working adults currently have a rainy-day savings fund, according to a survey commissioned by CWM Wealth Management.
- The top reason, for 47%, for not having a contingency fund, is not being able to afford to save.
- A potential emergency is the top motivation for longer-term savings for 54% of those surveyed, while 39% are saving for a special event or occasion.
- For parents, their kids’ education is the second most significant savings motivation, at 44%.
What is an Emergency Fund or Rainy Day Fund?
We are all vulnerable to unforeseen events at some point in our lives, sometimes due to circumstances within or outside our control.
According to Willis Towers Watson 2019/2020 Global Benefits Attitudes Survey, 40% of Irish households do not have enough savings to meet household bills for 6 months, if there is an emergency and their income is significantly affected.
Emergency funds also called Rainy day funds are liquid financial assets kept aside and readily available to cover spending in the event of income disruption or unexpected increases in spending or consumption without affecting your current standard of living. Emergency fund is just one component of savings that is normally used as a temporary gap to make up for financial disruptions.
Importance of an Emergency Fund
When you have an adequate emergency fund kept aside, it means that you are prepared for an unexpected expense and you can handle temporary financial setbacks is an important fund to have in your back pocket. When faced with unemployment, illness, and family emergencies that threatens your financial well-being and causes stress, an emergency savings will help ease the stressful situations. However if you don’t have an emergency fund then you expose yourself to financial ruin and living on the “financial” edge. You expect and hope to get by without running into any emergencies.
An emergency fund is important because you are prepared and it removes money worries from your problem list when unexpected events occur. Since the fund is out of your immediate reach, you will be disciplined to not spend when you feel like. Making a conscious effort to put money aside will discipline you to avoid making bad financial decisions because you will consider costs of borrowing, interests, fees and penalties to access cash which will be a drawback.
Types of Emergency Fund?
Emergency funds can be measured based on their varying degree of liquidity. Best to store your emergency funds to the quickest form of cash or its equivalent.
Most liquid form of asset. It includes cash balances in your savings account and current account and also money market accounts.
Similar to cash, with a short duration to access it and it has a low risk e.g treasury bills and certificate of deposits (CD)
It must be easily convertible into cash. This includes the value of Investment accounts that trades in stocks and shares with higher yield of return compared to other emergency fund types. The stocks and shares should be considered liquid.
How Much Do I Need in an Emergency Fund?
Now that you know what an emergency fund is, what it is important and the different types of emergency fund that you can create. You may ask, how much emergency fund is enough.
The use of monthly expenses is favoured to monthly income to determine the level of emergency fund needed.
The general assumption is that most people or households will maintain their expenses before and during their Change in income and salary. In most cases, spending changes in response to emergencies.
So the general recommendation is to keep up to 6 months of your expenses excluding any non essential luxuries.
There are 2 types of expenses, general expenses and discretionary spending. General expenses, are essential expenses such as food, rent, mortgage, fuel etc. while discretionary expenses include dining out, luxury items,
If you not sure where to start, Click here to calculate how much you need for Emergency Fund
Take The Right Steps To Build Your Emergency Fund
Step 1: Calculate how much to set aside in your emergency fund.
The amount you set aside in your fund should cover mortgage, rent, food, utility bills and other necessities every month. Now that you know how much you should have in your emergency fund, you can set your own goal. Stay realistic and remember that an emergency fund should at least cover rent, utilities, debts, and food for three months.
Step 2: Decide on a budget
Saving for an emergency fund doesn’t need to be painful. Look at your current income and spending, and see where you could cut back even a dollar a day. The more you can cut from your expenses, the faster you can save!
Step 3: Set up automatic payments
Setting up automatic payments can help take the hard work of saving out of your hands. Look for a savings account with a feature like Chase Autosave that lets you set up daily, weekly or monthly deposits from your Chase checking account to your Chase savings account. Chase Autosave also lets you save for specific goals and track your progress against them, so once you’ve built up your safety net, you can start saving for your next goal, like a vacation or college fund. Part 6.1: An Automated Budget
Seeing the importance of an emergency fund, I like to use an automated budgeting system to build up my savings in a disciplined manner. In summary, as soon as you receive your pay cheque, you will transfer a portion of your earnings into your ‘savings’ bank account.
Building an emergency fund is part of creating a functional budget. It becomes its own line item that you put money toward. Unless you receive an unexpected bonus, extra large commission or inheritance, you’ll likely have to build your account gradually over time. The good news is that this “expense” doesn’t last forever. Once you’ve hit your goal, you’re all set. That is—until an emergency strikes.
As for how to build an emergency fund, it’s pretty simple:
Set a total dollar-amount goal for your fund.
Determine how much you’re able to set aside each month.
Transfer your monthly contribution to the emergency fund on a set date each month. Treat it like any other monthly expense. You can even put your emergency fund on autopilot by setting up automatic transfers from your checking account or asking your employer to send a portion of every paycheck to the account.
Once you reach your goal, you can then reallocate your monthly contribution to other expenses or deposit it into your savings account. And if the day comes when you need to use your fund, you simply rebuild it by following the same steps.
Part 6.2: How much to allocate
Well, this is a very subjective question and it depends on your current financial position at this stage. Since it is imperative to have an adequate amount of rainy day fund, I will highly recommend you to accumulate as much as possible, and as fast and possible. Consequently, if you can set aside 50% of your monthly salary towards this financial goal, then do it. In contrast, if you are making ends meet, then start with a smaller amount that you are comfortable with, e.g. 5% of your monthly salary, or even just $10 a month. In either case, it must be remembered that you should set a realistic goal that you can achieve. This is so as to ensure that you remain committed and motivated to achieve this financial goal. Hence, don’t be embarrassed to start small. Remember, consistency is the key here!
Where Should I Keep My Emergency Fund?
You’ve heard the saying “out of sight, out of mind.” That’s the best way to store your emergency money. If the cash is only as far away as your closest debit card, you may be tempted to use it for something frivolous like a designer cocktail dress or big-screen TV—not exactly an emergency. Keep it in a safe place where you will have the full access to the full amount at any time without any stress. It’s best to keep your emergency fund separate from your other bank accounts. You want your emergency fund to be accessible in case you need to access it quickly—but not so convenient that you’re tempted to dip into it unnecessarily. You want to have a “set it and forget it” mentality when it comes to this account.
Here are some of the best options for where to keep an emergency fund.
1. High-Yield Savings Account
Opening a high-yield savings account to start an emergency fund makes a lot of sense. Almost all high-yield accounts are found at online banks. However, you can’t go to a brick-and-mortar bank location to withdraw funds. You’ll need the use of another bank account for transferring money in and out of your high-yield savings account. This could create a delay in receiving funds when an emergency arises.
With that said, a high-yield savings account is still reasonably accessible and allows you to receive a higher interest rate than a traditional savings account. Leading high-yield accounts earn between more than 2.00% annual percentage yield (APY), depending on the size of your account and other factors.
A number of online banks offer high-yield savings accounts. It’s important to look at rates when you open an online savings account, and also to pay attention to any fees, other perks offered and rules concerning withdrawals.
2. Money Market Account
Money market accounts are similar to high-yield savings accounts. While both earn a higher APY than traditional bank accounts, they are different in other ways. Money market accounts sometimes come with a debit card and check-writing capabilities, making them more convenient, especially in a pinch.
Another difference, which could affect your decision on where to keep your money, is that money market accounts generally require a larger minimum deposit to open an account. Some banks have tiered interest rates based on account balances.
You can open a money market account at most local banks, as well as at online banks. You may find higher rates online. Online banks can offer better rates because they don’t have all the overhead costs that traditional banks face. Whichever you choose, be sure you understand how to access your funds in a hurry, if necessary.
As with savings accounts, federal law has limited the number of withdrawals or transfers you can make from a money market account to six per month. Even though this Regulation D requirement was modified in 2020, you’re likely to face a fee from your bank or credit union if you exceed this limit. However, if your money market account is being used only in case of emergency, this shouldn’t be an issue.
3. Certificate of Deposit
Certificates of deposit (CDs) are another possibility for your emergency fund. They are different from other options on this list because they require you to keep your money in the account for a specific period of time in exchange for receiving a guaranteed rate of return.
A CD’s “term” can be as short as a month or as long as five or more years. Once it ends, you can access your initial funds and any interest you earned. CDs typically earn a higher interest rate than other bank accounts.
Earning a higher APY is great, but there is some risk with having your emergency fund tied up in a CD. What if you face an emergency before your CD has fully matured? You can still withdraw money from a CD during this time, but in most cases, you’ll have to pay an early withdrawal penalty. Some banks charge a flat fee, while others may charge a percentage of the interest earned on your CD.
Paying a fee isn’t ideal and can defeat the purpose of choosing an account that earns higher interest. In a way, it’s like gambling on whether you’ll face any emergencies during that time period. There are a few no-penalty CDs, but you’ll need to read the fine print to be sure that the no-penalty feature isn’t tied to a specific circumstance like losing your job.
One way around this is to create what’s called a CD ladder. This involves rolling over several CDs of varying term lengths. Doing this allows you to earn at a higher rate while leaving some of your emergency fund accessible. You could have one CD with a three-month term, another with 12 months, another with 18 months, and so on.
Individuals can open a CD account at almost any bank. There also are online banks that offer CDs with more favorable rates or better term options. Some CDs have minimum deposit requirements, while others don’t.
4. Traditional Bank Account
If the idea of keeping your money in an online account or tied up for an extended time doesn’t sound ideal, you can always keep your emergency fund in a traditional checking or savings account with a brick-and-mortar bank. You won’t earn as much interest, but you have the peace of mind that comes from knowing you can access your funds almost immediately at any time.
One risk with this strategy is that keeping your emergency fund in a traditional bank account could lead to your withdrawing money when it’s not truly an emergency.
To combat this, you could open an account at a different bank from your other checking and savings accounts. This can at least add a degree of difficulty that may help keep you from pulling funds out when you’re not facing a real emergency.
5. Roth Individual Retirement Account
There is a case to be made for putting money into an investment account instead of keeping a more conventional emergency fund. Even bank accounts that earn high-yield interest won’t keep up with rising inflation. Investing your money in a Roth IRA would probably earn more money in the long run.
There is a risk to keeping your emergency fund in a Roth IRA because it could lose value. Choosing more conservative investment options can help lessen the risk of loss.
You can withdraw your contributions from your Roth IRA at any time with no penalty. There may be tax implications and early withdrawal penalties for withdrawing earnings.
When Should I Use My Emergency Fund?
Here are some of the top emergencies people face:
Job loss.
Medical or dental emergency.
Unexpected home repairs.
Car troubles.
Unplanned travel expenses.
A financial emergency is an event that causes an unforeseen expense, like a car repair or a medical bill. Reserve your emergency fund for these situations and don’t hesitate to use it when you need it – that’s what it’s there for! The key to building a reliable emergency fund is to continue replenishing it after you use it during downtimes.
Ideally, expenses such as taxes and home repairs shouldn’t come out of your emergency fund. You should set up a budget that has room for costs you can foresee. However, using your emergency fund is a better alternative in these scenarios than taking on debt.
If and when an emergency strikes, you can transfer money from your emergency fund to your checking account—or withdraw it at a branch—then spend it the same way you typically make purchases and payments.
But depending on the type of emergency, you might not be able to transfer funds or visit a bank branch. If you find yourself in a situation that requires immediate payment, use a credit card, then pay off the balance with your emergency fund as soon as possible to avoid interest fees.
Final Thoughts
Creating an emergency fund means you are making a financial commitment to yourself. You are pledging to alleviate yourself and your household from financial distress during an unexpected and difficult times.
Some other questions you may want to ask yourself are:
Is my career path or industry particularly risky?
Do I reliably make the same amount of money every month?
Could there be times when I make less than I do right now?
Have I budgeted for my whole family? How will my family’s financial needs change down the road?
If you don’t think you can hit the recommended target of 3 to 6 months of savings, remember that something is better than nothing. Start saving in small amounts every month, and soon you’ll have a nice cushion.
Efforts should also be made to improve the household’s ability to save. Financial planners could first help households set up saving goals, and then outline steps toward meeting these goals. The government could entice households to save more by offering tax breaks for target levels of monetary assets, such as money in savings accounts and short-term CDs. Direct deposit of tax refunds could encourage saving by households.
An emergency fund can help you gain more control over your finances, contribute to your financial freedom and provide peace of mind. The best time to start building an account is when you’re not in the middle of an emergency, and you can adjust your goal as needed.
Although it is crucial to set aside this pool of money, there is no need to overdo it. For example, after assessing your need, you may realise that you only need two months of rainy day fund. By comparison, you may have a lot of commitments and feel that eight months of rainy day fund will give you a greater peace of mind. With this in mind, here is what I will suggest you to do: Take a piece of paper and draw a mind map of all the unexpected events that may affect your financial wellbeing. For example, if you own a car, then you may require slightly more liquidity for car maintenance as compared to someone who don’t own a car. Consequently through this exercise, in addition to understanding yourself better, you will also become more confident about your finances. In any case, just bear in mind that there really isn’t much meaning to having excessively excess amount of money in the bank doing nothing. Therefore, just hold onto what you need and use the remainder to work on any financial goals that you have.
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Important Disclosure
This material is for information purposes only and should not be taken as financial advice. You should talk to a financial advisor who will assess your personal circumstances and provide a suitable advise.
