Unfortunately, life doesn’t come with an itinerary. There’s no schedule, no list, about what will happen and when. Sometimes the things that come our way are good, at other times less so. It is for these ‘other times’ that we need to be prepared, to have an emergency fund that is adequate enough to cushion a hard-hitting blow, if not mentally, then at least financially.
What is an Emergency Fund?
In simple terms, it is a savings account – one that you must feed, and one that you must forget about. It is created for the sole purpose of stashing away money to use only in case of an emergency. We all define emergencies differently, but let’s call an emergency any time you find yourself in an unplanned situation that you didn’t budget for at the beginning of the month.
Here are some general guidelines for your emergency fund:
- Aim to save enough money that you could get by for three to six months with no income. If you don’t know your monthly budget, create one by tracking your expenses for a month. Include monthly expenses: groceries, gas, and recurring monthly bills. Assume you will likely be tightening your belt and skipping weekly date nights or other discretionary spending categories in your budget.
- If you are self-employed, you should save six to 12 months worth of expense. This will help you buffer irregular income.
- Keep your emergency fund in a separate account.
- Set a goal for your emergency fund and incorporate a contribution into your budget. For instance, let’s say your goal is to save AED 5,000. Create a realistic monthly goal towards that amount, say AED 200 to AED 400 a month. It doesn’t matter how much you save each month but commit to saving something, and treat it like any other bill you pay.
- Don’t freak out about having to use your emergency fund — that’s what it’s there for! Just work to rebuild it once you’ve dipped into it.
- If you get a bonus or salary increase at work, think about also increasing your commitment to your emergency fund, either by dropping in a lump sum or by setting a higher monthly contribution amount.
Why do I need an emergency fund if I have a savings account?
We’re pretty sure you might be wondering, “Why do I need an emergency fund when I already have a savings account?”
Because, the whole idea of an emergency fund is to not use it unless there’s an emergency. Whereas that’s not the case with your savings account, is it? Don’t we all empty our savings account the minute we have an extravagant want, say for example, a new phone, car, holiday etc.
Your emergency fund must be a vital piece of your financial plan. You can continue to contribute your savings account for that luxurious vacation you want, and also contribute every month to your emergency fund.
Once you hit your emergency fund goal amount, feel free to back off your contributions and put more in your other savings accounts. It might be a few months or a few years until you need to tap into your emergency savings account, but the good news is that it’ll be there when you need it.
It’s always a smart idea to put your emergency fund in a place where you aren’t likely to touch it. Another advantage of separating it from your traditional savings is that you might find an opportunity to earn more interest.
Saving for an Emergency Fund when you’re short on cash
It might seem really tricky to set out money for your emergency fund when you’re living paycheck to paycheck or you have debt. However, it’s not impossible.
The first task is to make sure you have a monthly budget in place. You can use an Excel spreadsheet, Post-It notes, or mobile apps to help you set one up.
There isn’t a right or wrong way to create your budget. You need to figure out what works for you and what will keep you motivated. However, an important piece of your budget is tracking what you’re spending every single dirham on. When you track your spending, you’re empowering yourself to make changes, so you don’t need to turn to even more debt. Plus, if you know where your money goes, it’s easier to uncover possible savings and make adjustments that can lead to savings.
Here are some ideas to get your savings plan in place when you’re struggling to make ends meet:
- Break your emergency fund goal up into manageable mini-goals each month or each week even if it’s a small amount of money
- Find an expense that you can eliminate or cut back on and put those savings into your emergency fund each week
- Your emergency fund will ebb and flow, so remember to remain calm and keep saving
Remember, an emergency fund will help you avoid having to turn to a credit card and the cost that goes along with using it for something that you can’t already afford.
Here are some tips for those times when you do need to use plastic for an emergency expense:
- Use your credit card with the lowest interest rate and make a plan for paying off the balance in the shortest time possible
- Call your credit card issuer and ask if they have any low interest or 0% interest options
- Check out personal loan companies to see if you can get a lower interest option before you turn to your credit card
As your life grows, so should your emergency savings
Your emergency fund is your financial back up. And this back up must grow in proportion to the developments in your life. As you cross new milestones like getting married, having a baby, etc, your financial responsibilities will only increase. So keep feeding your fund.
Once you have a three-month fund, aim for six. Once you have a six-month fund, aim for a year. Check your emergency fund balance regularly and make sure it can cover your monthly expenses for the length of time that makes you feel secure and comfortable.