How to Set Up an Emergency Fund

Actively maintaining an emergency fund is crucial given the current economic landscape, especially for those who belong to the working classes and rely on a single stream of income or are irregular.

However, as per the US Bureau of Economic Analysis findings, the personal savings rate remained 12.9% in November 2020 – even lower than the previous months.

Simply put, this means not enough people are saving.

In another worrying sign, as per research conducted in the USA, only a surprising 41% of Americans could handle a $1,000 amount in the event of an emergency. 

The majority 59%, however, largely remained unprepared. 

What is an emergency fund?

A starter emergency fund comprises savings you put aside separately and don’t use unless it’s a real emergency. People’s perceptions about what constitutes an emergency may vary, but a consensus can be reached that it is often a situation where you cannot survive without some extra money. 

Others may also constitute an emergency fund as extra savings that you put away for some emergency occurrence, such as an unfortunate medical event or unexpected bankruptcy.

Why you should set up an emergency fund

Even for reputed financial gurus with decades of experience, it has become hard to predict what will happen in the economy, given the turbulent times in which we exist.

Just last year, the world was faced with catastrophes that brought the economy to a standstill, from the global COVID-19 pandemic, widespread global wildfires, and the eventual 2020 stock markets crash.

Everyone has been impacted by these events in some way, somehow. Whether there has been some huge hit on your finances may differ; however, that is not to say that the world at large has been reminded of how important it is to keep your finances in check. In any case, think of an emergency fund as your insurance policy for avoiding severe issues in the future. If those events above tell us anything, the world is unpredictable, and anything can happen.

Kickstarting a starter emergency fund by dedicating what little amount you can save is an essential part of prepping for a rainy day scenario. 

Emergencies do not announce themselves before arriving, and it’s not a matter of if but when they arrive!

1) Set a monthly benchmark budgeting goal

Neatly organizing and allocating all expenses with careful budgeting is the key to quickly establishing an emergency starter fund. It also helps to identify the benchmark amount to be set aside for savings.

You may want to save funds for anywhere from one to three months of expenses. 

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The key to start is to set up small, achievable goals. This number can be from $500 at the start to $2,500 every month. Note that the fund should be based on your expenses and how much is actually coming in. If your monthly costs exceed an initial fund goal of $500, you need to cover that difference.  

You can also use an emergency fund calculator to calculate the estimated amount you need to save and see how long it could last. 

2) Choose a suitable option to secure your fund

A checking account with a debit card could suffice for prompt access to liquid cash, but you can also keep the initial funds in a high yield savings account that you can readily access anytime you need. Any additional funds can then be placed in low-risk money market accounts or a certificate of deposit (CD)

Once you have chosen an option, start by scavenging through your stuff and putting at least $1 in it to motivate yourself. Keep in mind:

Little drops of water make the mighty ocean.

Pro Tip: Keep the emergency funds separate from your regular checking and savings accounts to avoid the temptation of making an unnecessary withdrawal. It is best to put it away and not think twice about the account, as the less it’s on your mind, the less you’ll be tempted to touch it.

3) Begin allocating money to the starter emergency fund

The effects of rising inflation, reduced purchasing power, and other economic troubles will be tricky to overcome. However, taking up this challenge to be consistent is the only viable solution if you want to stand your ground in case of an emergency. 

It may not be easy, but there are ways to find extra cash if you are serious and disciplined enough. Here are a few strategies on scraping by some extra cash for your emergency fund:

  • Reduce expenses — Reduce expenses by identifying your overspending and implementing a spending freeze (not spending for a certain period). You can do so by listing and tracking your expenses with a budgeting app, prioritizing essential “needs” (food, rent, utilities) over any wants.  
  • Start a side hustle — There are plenty of side hustles that people can start these days, from starting your own business via Shopify or other online platforms to freelancing on the side.
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4) Extend the scope of your emergency fund

Once you have built the starter emergency fund, focus on the debt obligations, and then aim for a larger emergency fund covering at least six months of expenses. Don’t stop once you reach the long-term goal, too, however. Keep building throughout, as emergencies come in all shapes and sizes, so having as much backed up can only benefit you in the long term.

Final Thoughts

Setting up an emergency fund brings you one step closer to achieving financial freedom. The resulting peace of mind is definitely worth the effort.

It can be tempting to dig your hands into an emergency fund whenever the time may need. However, its important to remind yourself of the three questions below whenever you feel tempted:

  • Is the incident unplanned?
  • Is the need to use my emergency fund essential?
  • Is the situation critical?

If you feel confident that the answer to these questions is affirmative, then feel free to touch your emergency fund. Just keep in mind that this fund is used for emergencies only and there would be no purpose to having one set up if you used it whenever need be.