Emergencies call for unique decisions, but the numerous unexpected global events that have come to pass recently may leave you wondering how to make the best financial decisions for you. During the last five weeks, the US economy lost more than 26 million jobs, ending a decade of job growth. With the daily news updates on the stock market, the price of oil reaching negative prices, and unemployment soaring, the economy has been shaken to its core, permeating across markets and economic sectors and affecting with great force the finances of companies and households across the globe.
Faced with unexpected circumstances that demand swift actions, individuals must take cautious measures to safeguard their finances and attend to possible contingencies that may arise in the short and medium-term. One of the most overlooked, but crucial methods for safeguarding your finances is building an emergency fund. An emergency fund is a reserve of cash savings to cover unexpected expenses (medical bills, urgent repairs) or potential financial emergencies (a job loss). Ideally, your emergency fund should have enough to cover your expenses for a period between three and six months. While it is an effective and expert-recommended measure, it is not used by many: a Federal Reserve study found that 39% of American households are unable to cover an unexpected expense of $400, while another 27% would have to borrow to be able to pay for it. Amid economic and financial instability, having an emergency fund can ensure you’re able to cover your expenses regardless of external situations.
How To: Build An Emergency Fund
Monthly Cash Flow Analysis
The first step in building an emergency fund is having a holistic understanding of your finances. A detailed review of your monthly cash inflows and outflows will not only let you know how your income is compared to your household expenses. It will also give you insight into what expenses you can eliminate in order to optimize your budget. You can direct any saved funds to your emergency fund.
Define Your Goal
Once you’ve identified your expenses, you can determine your ideal emergency fund amount. Initially, make your goal to save a sum equivalent to three months worth of expenses. That value will come partially from the optimization of monthly expenses that you identified in the analysis phase of your current budget. Reducing your spending may seem like a big sacrifice, but if you compare it to the risk of not having available funds in the event of an unfortunate event, it will be well worth it.
Once you have your first three months of expenses saved, you’re halfway there! Like any habit, consistency is key, and completing the 6-month savings goal will be much easier as it becomes a normalized piece of your financial plan. It is essential that you give the goal to reach your emergency fund the same importance as a high priority monthly expense.
How and Where To Save Your Emergency Fund
The fund should be opened and kept in an independent savings account, ideally in an FDIC-insured bank, or in easily accessible financial products that produce profitability, that are low cost and do not have penalties attached. Less orthodox approaches suggest that assets that retain or increase their market value and are easily liquidated may be part of your emergency fund, but we’d recommend sticking to the safest long-term approach.
Keeping Your Emergency Fund In Check
It is important to make a periodic review – biannual or annual – of the configuration and value saved in your Emergency Fund to correct according to the different microeconomic indicators, national or global financial perspectives, such as the current emergency due to COVID -19, and the financial situation in your household such as job changes, your child’s education, new investments, acquisitions of vehicles, or real estate.
The Tangible and Intangible Advantages
An emergency fund not only supports the day-to-day expenses of a home during times when there is reduced cash flow or large unexpected expenses; it acts just like a fuse in an electrical system. It protects the different parts of the circuit containing the energy peaks.
In the same way, your emergency fund can keep you afloat during unexpected times while protecting assets and savings or, in many cases, avoiding incurring medium-term debt. Difficult times don’t mean your peace of mind should suffer. so if you’re able, consider building an emergency fund while other expenses are low. The peace of mind that comes with an emergency fund can help you ensure you make the best financial decisions regardless of external factors.
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Real financial planning should pay off today. Not in 10 years time