This post is probably 12 months late. As we are in the middle of a global pandemic, people are losing jobs, lives. But even more are coming to realize that they miss something truly important: An emergency fund.
I got to admit, I am also not a great role-model here. Over the last 5 years, every penny I got was being invested right away. Therefore I have not built up a proper emergency fund. This is changing now.
How much is enough?
I read several surveys from Germany and the US last year. While I don’t remember exactly the numbers, they were overall pretty similar in their final assessment. A majority of citizens (of each of the countries) are not prepared to handle even smaller unexpected (emergency) expenses out of the pocket. How small? We are talking about 300 Euros or 350 USD.
I was honestly shocked by reading about it, because 300 Euros is very little, especially when we are talking about the US or Germany. For most people, it wouldn’t be enough to cover monthly rent, groceries, let alone a potential hospital bill or car repairs.
So obviously 300 Euros is not enough and wouldn’t qualify as an emergency fund. An emergency fund is meant to offer us protection in times of real need. When something happens that threatens our 3 basic needs (shelter, food, health), possibly over a prolonged period of time.
It needs to be therefore large enough to cover our regular monthly expenses for a specific timeframe. Most financial advisors recommend 3 to 6 months.
Therefore, to determine the size of your emergency fund all you need to know is about your monthly expenses and multiply this amount with a minimum of 3 months. If you are a cautious type or consider yourself for whatever reason to be more at risk, you might want to multiply it with 6 or even 12 months.
How to get there
Of course, you are not supposed to put this money aside right away. If your monthly expenses are around 1.500 Euros, it would mean that your emergency fund should be at a minimum of 4.500 Euros to cover expenses for 3 months. If people can’t get 300 Euros out of the pocket, how can they save up 4.500 Euros?
The solution to this is of course time, consistency, cautious choices, and the occasional sacrifice.
If you are saving monthly for a certain financial goal, a part of that monthly savings needs to be redirected towards your emergency fund. When you get a salary raise or a bonus payment, you might want to skip the celebrations and put the money into your emergency fund. If you are a coffee addict, how about skipping two cups of those soft lattes each week and putting 10 dollars each week in your emergency fund instead.
This step by step approach might take time, but unless you have an emergency every few months, you should be able to get to your goal within a reasonable timeframe.
The last option is to take on a side-gig. Sacrificing a little more time for a few months or a year might prove the right choice down the road. Having an emergency fund in place will protect you not only by covering any expenses that might unexpectedly pop-up. It will also protect your investments and other financial assets. Because you won’t get under pressure to sell them when money becomes an issue.
Keeping it liquid
An emergency fund needs to be liquid, which means that it must be easily accessible and not tied up to anything. Usually, you will, therefore, keep it in cash, on a simple savings account, or as a fixed deposit which can be easily withdrawn.
I have decided to split it. I keep one month of expenses in cash, and over the next 6 months I will set up a fixed deposit account with enough money in it to cover another 3 months of expenses.
No matter which way you chose, but having some money on the side for the next pandemic, the next wave of cost cuts in your industry (meaning when you get furloughed), or the next car accident, is surely worth the effort.