Money Mastery: Emergency Fund Essentials – Size and Strategy

In Part 1 of this series, we explored what an emergency fund is and why it’s the cornerstone of any solid financial plan. If you missed it, think of an emergency fund as the moat protecting your financial castle from life’s unexpected curveballs. Now, let’s dig deeper into the practical aspects: how much should you save and where should you keep it?

How Much Should You Save?

There’s no one-size-fits-all answer to this question because your ideal emergency fund depends on your unique circumstances. Here are the key steps to figure it out:

1. Calculate Your Monthly Essentials:

   Start by listing your essential living expenses—housing (rent/mortgage), utilities, groceries, transportation, and debts. This forms your baseline.

   
   

2. Determine Your Cushion:

   Multiply your monthly essentials by the number of months you want your fund to cover. Most experts recommend 3 to 6 months, but if your income is irregular or your job stability is uncertain, aim for higher.

   
   

3. Adjust for Life Factors:

   Family size, lifestyle, and potential risks (like being self-employed) influence how much you need. The goal is to create a safety net that feels right for your situation.

   
   

Where Should You Keep Your Emergency Fund?

Choosing the right home for your emergency fund is just as important as saving for it. Here are the top considerations:

1. Accessibility:

   Your emergency fund needs to be easily accessible when you need it most. A high-yield savings account is an excellent option because it balances accessibility with a bit of growth.

   
   

2. Liquidity:

   Your fund should strike a balance between accessibility and protection from impulsive withdrawals. On one hand, it should be easy to withdraw without penalties or delays in case of a true emergency. However, you don’t want it to be so liquid that there’s no barrier to entry. Having a small restriction, such as keeping the funds in a separate account without a linked debit card, can help prevent the temptation to dip into the money for non-emergencies. This ensures your emergency fund remains intact for the situations it’s meant to address.

   
   

3. Low Risk:

   The main purpose of your emergency fund is security, not profit. Select accounts that offer stability, even if the returns are modest. High-yield savings accounts or some unit trusts are solid choices.

   
   

Common Myth: “I Can Use a Credit Card Instead of an Emergency Fund”

While credit cards can be a backup in dire situations, relying on them for emergencies can quickly lead to debt spirals due to high interest rates. An emergency fund gives you peace of mind without adding financial stress during a crisis.

FAQ: “Should I Invest My Emergency Fund to Make It Grow?”

It depends, investments like stocks or bonds come with volatility or liquidity risks, which make them unsuitable for emergencies. However, there are unit trusts that can grow at higher rates than most savings accounts and have no holding period penalty. (A fee the investor have to pay if they plan to remove their investment before an agreed time.)

Speak to a representative at your bank to determine what unit trust is suitable for you. Remember, your emergency fund’s primary purpose is to be readily available and reliable when you need it most. Keep it simple and safe.

Now that you’ve learned how to determine the size of your emergency fund and where to keep it, take a moment to reflect on your current situation:

●       Do you know your monthly essential expenses? 

●       How many months of expenses would make you feel secure?

●       Where are you currently keeping your savings, and is it meeting the criteria for accessibility, liquidity, and low risk?

Small steps today can build the fortress that protects you tomorrow. Whether you’re just starting or refining your plan, the key is consistency.