I wanted to take a different approach with this article that talks about putting aside money and how it doesn’t really make you that much more money. Instead, it protects you when revenue sources that do make you money or enable you to do so fail. Examples may include loss of a job (and subsequently fixed income), medical emergencies and vehicular emergencies not covered by insurance amongst others – really the list can go on forever.
What is an emergency fund?
Think of it as insurance but instead of you paying some bank or agency month after month or annually, you put aside in an account and forget about it. Why forget about it? Because if you start counting that in your daily access to liquid capital, you’re bound to consume it – defeating it’s purpose.
An emergency fund, as the name suggests is a self managed and regulated fund you create to deposit money today for when you might need it tomorrow. It is to be used only in the absolute worst case scenarios and not to buy things like a Gucci top or Armani jacket.
How much in the fund makes it an emergency fund?
Whether you put asie $1/ day or $100 a month out of your in-hand paycheck (after your 401k cuts – if you have one), all the money that goes into this fund and isn’t touched thereafter unless for it’s intended purpose counts towards the fund.
I would recommend a minimum of $1000 if you are a student and $10,000 if you are employed. Whether you put together this fund in one day or over a period of time is up to you, but the earlier you start and the larger sums you can put aside the better. Just don’t concentrate too much on putting everything in the fund that you’re unable to make day-to-day expenses when you are financially afloat/stable with a constant in-flow of cash.
How do I create and manage the fund?
Start with creating a financial review of your past transactions. Always start with categorizing your cash in-flows (in-hand salary income, stock yields, bond yields, rent you receive from existing properties) and out-flows which include your expenses and/or payments towards loans.
Additionally decide how much you wish to put in savings – not to be confused with the emergency fund – and how much you plan to spend in the future – month by month.
Why month-to-month? It’s easier as you can split up the cost over time if you have annual payments such as insurance.
How are savings different from an emergency fund?
Savings are what you put together to use when you plan for your future. Want to buy a car, a house or travel with the family on vacations – those are transactions that come out of your savings. You always have access to your savings – to either withdraw cash, pay loans, credit cards or pre-existing debt.
While you have access to the fund, you do not touch it unless things go south and you run out of savings.
So should I just make another bank account to put my fund in?
I personally would create a savings account with a bank which has no links to any of my cards or payments and never use it’s information anywhere. The reason for a savings account is that some offer good rates compared to a checking account – which almost offers nothing.
Another way is to keep physical cash locked away either in a safe or locker at the bank (charges may apply for this). I feel putting it in a bank is always best because it will be FDIC insured so even if the bank goes under, your funds are safe.
If you get a debit card with that account, cut it up so you have no way of accessing that account unless you physically walk to the bank to withdraw cash (this is an extreme case if you really have control issues).
Like I mentioned earlier, this is money you put aside to protect yourself for when your savings either run out or you have no other option but to use cash for when you get hit with something unexpected – just like an insurance. But it’s better than an insurance because the rates don’t really rise the next cycle as you’re not really paying anyone and not becoming a liability to someone else.
Some accounts you keep the fund in may give you a 1% or 2% interest back if you keep money in it long term but that is not the intended purpose. An emergency fund is not to be confused with an investment which may give you higher returns.
While it is an investment towards safeguarding yourself in the future from unprecedented events it is not one to make you money.
If you want to make money off of your savings, by all means invest part of it in vehicles that are known to generate an ROI. This could include purchase of stocks, a high interest yield savings account (with the FED increasing rates, earn rates are at all time highs) or park your money in mutual funds that do most of the work for you and provide you a financial summary of what you made (or potentially lost if the markets’ performance dipped).
I will cover the various means of parking your savings in future articles which will include financial vehicles such as High interest yield accounts, brokerage accounts, Certificate of Deposit (CD).
If you have any questions, feel free to leave them in the comments and I will answer them ASAP.