Emergency funds can prove to be crucial to our personal finance. Building a buffer is, in fact, one of the tools which you should master before you’re 30 [Link to financial lessons before you’re 30 post]. Even people with the most reliable and regular source of income can find themselves in need of a sudden and unforeseen expense (like a medical expense, house repairs, etc.) or can find their usual source of income impacted due to some external reasons (the current COVID pandemic is a wonderful example). This sudden cash-crunch has the potential to occur to any (or all) of us during our lifetime, and it’d do us loads of good if we had an emergency fund securely maintained. More than anything, the mental peace and the sense of safety that having an emergency fund provides is more than enough of an incentive to start building your own.
Here is a list of steps that you can take, which will help you create your own emergency buffer
#1 Calculate the Target Amount
Calculating the desired end level of money should be the first thing that you should do if you’re just starting out on creating your emergency fund. Emergency funds should typically have two-three months worth of your monthly income. We had talked about how we arrive at this number here, but here’s the gist. Financial experts have formulated a rule (called the 50/30/20 rule) to theorise how a person should ideally spend their monthly income. According to this rule, you should ideally spend 50% of your monthly income on necessities, 30% on wants and luxuries, and the remaining 20 goes towards their future. So, by saving up two to three months’ income as your emergency buffer, you’ll be able to survive four to six months by living off your necessities. And this four to six months is an estimate assuming the worst possible financial crisis (an assumption that you don’t earn anything during this period). This should give you enough time to figure out a way forward (getting an extra job, applying for a long term-loan, etc.) if the situation persists.
#2 Maintain Monthly Goals
If you’re starting out on building an emergency fund, it’s unlikely to be practically feasible for you to sufficiently fill it in a single go. Just like any other financial target, it is important that you plan your emergency fund over a reasonable period of time. It is essential that you spread the payments out throughout some months (you still have other payments to make) while ensuring that you don’t leave it until it’s too late. You never know when a financial emergency may occur, so it is advisable that you fill your funds as soon as possible. We recommend that you maintain a monthly payment goal earmarked specifically for building an emergency fund. This way, you’ll still be able to make all your monthly payments without compromising too much on your lifestyle, and have successfully built up an emergency fund at a healthy pace.
#3 Maintain A Separate Savings Account
Maintain a separate savings account, apart from your regular bank account, used solely for maintaining your emergency fund. While this step is not an absolute necessity to build a buffer, it makes your life a lot easier. Apart from the obvious benefits, like the ease of management and a small (but significant) income by the way of interest, it also reduces the temptation to spend this money. We human beings can have the tendency to consume our entire bank balance, and this tendency can have a negative impact in times of crisis. An additional step required to spend this money will prove to be a sufficient discouraging factor and will help you effectively maintain an emergency fund.
#4 Live Like You’re Broke
Well, not always. But while you’re building an emergency fund, you should. Revisit every single one of your payments and scrutinise them to determine if they’re necessary. See if you can find offers on products you regularly use, and compromise (just a little bit) on convenience. This extra step can help you build an emergency fund a bit quicker, and in hindsight, you’d really appreciate the fact that you took the extra step. This mentality can prove to be effective when working towards your other financial goals too, but it is important that you don’t overdo it. You have worked hard for your money, and you should be able to utilise it in whatever way that you deem fit. That being said, living like you’re broke will definitely make achieving your goals faster than what is otherwise possible. Find the right balance and see what works out for you.
At the end of the day, personal finance is not an exact science. All the lessons and advice shared here in our blog should be applied differently in the context of your own scenarios, since different people would have distinct ways in which this would work best for them. There is no one specific formula to succeed in personal finance.
Salt, once officially rolled out, will offer you tools designed to help you achieve your financial goals. For further details, contact our team, we’d love to hear from you!