5 Steps to create an emergency fund from scratch
Learn how to create an emergency fund, learn about its advantages, and characteristics, and how to calculate the minimum amount your mattress should have.
If you are interested in keeping your accounts afloat or protecting your financial stability as much as possible, you must have an emergency fund.
Setting aside cash to cover extraordinary expenses is an excellent strategy to stay out of debt.
Therefore, you must understand the value of this emergency mattress, and how it can save your life in the event of certain unforeseen events and money setbacks.
Emergency funds, a financial lifeline
Today we will tell you what an emergency fund is, how you can create it easily and simply, and how to calculate it based on your fixed and variable expenses.
Taking control of your finances speaks volumes about your attributes and financial intelligence, and certifies that you are determined to act correctly to protect your assets.
In advance, we can tell you that these funds are very useful and necessary today and that you should have them if you want to avoid financial imbalances.
What is an emergency fund for?
An emergency fund allows you to cover unforeseen expenses, or expenses that you simply did not have planned on a financial level.
It is a cash reserve that plays a fundamental role in facing financial emergencies without having to affect your general budget, or without incurring unnecessary debt.
This additional money that you reserve for exceptional cases can become your best lifeline when facing any expense that is not classified as routine.
If you have this fund you will be able to overcome the unforeseen events that come your way in life more quickly, and without putting your savings or finances at risk.
If your car breaks down, if you get sick and don’t have an insurance policy, or if you face a period of inactivity at work, you would have a fund on hand that would make you feel more confident amid those stressful situations.
Characteristics of an emergency fund
Emergency funds have very particular characteristics, such as those that we will share with you below:
- This cash is not part of the monthly budget.
- It fulfills the functions of a financial lifesaver.
- It is used solely and exclusively to pay expenses that may arise unexpectedly (those over which you have no control).
- Avoid the costs inherent to debt.
- Commonly, the money allocated for the emergency fund is equivalent to the regular expenses that you would have to assume for six months, such as payment for basic services, insurance, schools, rent, etc.
- The money in the fund has immediate liquidity. This implies that you could have it easily and expeditiously when a setback occurs.
Specifically, this type of monetary reserve is characterized by offering you security and confidence in times of uncertainty or financial crisis.
For this reason, you must give it the attention it deserves, especially if you would like to stay away from loans and debts.
How to create an emergency fund
Creating an emergency fund is not complex or tedious. Anyone can do it successfully. Below we will share some basic steps to create your emergency reserve:
1.Define its dimension
This is based on a basic premise: your emergency fund should be as large as the risks that could arise in the future.
That is, the more complex or challenging those risks are, the greater the impact they will have on your finances.
Therefore, you should think about those setbacks that could play tricks on you at some point, as well as what it would cost you to overcome them if you do not have a reserve of money.
For example, one of the biggest risks that you should evaluate would be the loss of your job, or a drastic decrease in your income (if you are self-employed).
Another factor that you cannot overlook when defining the size of your fund is related to your health.
That is, if you have pre-existing conditions or a hereditary disease, you should also take the corresponding precautions in advance.
If you try to calculate the amount of money you might need if you have a medical emergency, you will likely be able to define the strength of your fund more accurately.
2.Evaluate your monthly expenses
If these guidelines seem a little complicated to you, then you should resort to an infallible formula: do your calculations based on your monthly expenses.
Another good idea is to use an emergency fund simulator to make your work a little easier.
Nowadays there are many tools of this type on the Internet and there is no cost to use them, so you should take advantage of them if you want to save time and effort.
The clearer you are about your fixed and variable monthly expenses, the easier you will be to estimate the amount of money you need to have set aside as an emergency fund.
3.Make basic planning
To do this you must analyze both your income and your expenses very well. Otherwise, you will be unable to create a personal budget or basic planning that will keep you focused.
You must know that creating this fund will take time, discipline, and organization.
Indeed, a person with a good job and financial stability could take between 20 and 30 months to complete their emergency fund, taking into consideration that they would be saving 10% of their income.
Some recommendations that you could follow to achieve your goal consciously and efficiently would be
- Automate your money savings (you could program discounts for your savings account).
- Lean on some automatic deductions from your salary (this is something you must agree in advance with your employer).
- If you are an independent worker, you could define a maximum level of monthly expenses (that way you can save all the additional money you receive each month).
- Set rules for extraordinary income (those you weren’t counting on). It would be best to save at least half of them.
- If you are a hired worker, you can use some bonuses, such as bonuses, or a double salary, to create your emergency fund.
If you want to know if your plan is working, do this simple equation: subtract your expenses from your income and see if you have any money left over.
If so, you must use that surplus to increase your fund, until it finally reaches the desired size.
4.Respect your emergency mattress
Although this is not a step as such, it is important to present it to you because it represents a critical success factor. It’s simple, if you do not commit to the process, nor respect your emergency cushion, you could be tempted to use it in an arbitrary or unjustified way. In simple words, you could start using that reserve money to cover expenses that do not qualify as emergencies. So you could become your fund’s worst enemy, especially if you are a beginner in the subject, or if you do not rely on the financial commitment mechanisms that exist in the market to protect your reserve.
5.How much money should your emergency fund have?
In theory, the amount of money that should be in an emergency fund depends on the status and current situation of each individual.
However, a moment ago we told you that experts recommend that you save enough money to cover expenses for three or six months.
A quick way to know how much money you need to reserve for any emergency is to do a simple calculation of your expenses. To do this you must divide them into two large categories:
- Fixed expenses: those that you assume regularly, such as insurance, housing, etc.
- Variable expenses: their cost may change and some of them cover transportation, medical bills, or food.
The amount obtained will indicate the size of your emergency fund, although you must understand that this amount must be reviewed annually.
That way you can update it and adjust it to the possible economic variations that you are experiencing (don’t forget that money tends to devalue over time).
Where to keep reserve money?
This is a very important question that you should not stop asking yourself if you want to move in the right direction.
Some financial experts agree that the money in your fund cannot be deposited, or kept, in the checking account in which you have your frequent expenses direct deposited.
The reason is simple: it will be more difficult for you to keep track of expenses and you could end up using your reserve to solve situations that are not an emergency.
So you should avoid, at all costs, using that money in fixed-term deposits, or any other similar product.
Recommended financial products
Taking into consideration that the money in your fund must have immediate liquidity, the best option to keep it protected and available is to opt for financial products that are risk-free.
This will ensure that your capital remains fixed or immovable, which will make you feel more confident and calm. In essence, you can rely on:
- Investment funds that focus on fixed-income or short-term financial assets.
- Paying accounts that encourage savings, and that also pay interest.
- Collective investment funds (FIC) that do not have permanence agreements, risk your money or have high costs.
One of the worst mistakes you can make is to keep your money at home since it will gradually lose its value due to factors such as inflation.
Therefore, you should make sure that your emergency reserve is anchored in a financial product that offers you at least a little return and is easily accessible.
The importance of having an emergency mattress
Surely you already know what an emergency fund is for. But we would also like to share with you some intelligent and very useful recommendations:
- According to a Business Insider article, these types of cash reserves keep you protected during worst-case scenarios, including unemployment or illness.
- Having an emergency fund offers you financial security and peace of mind.
- You are free to access other financial goals, such as investing in real estate, or other highly profitable products.
- Prevent you from going into debt, or requesting last-minute loans to solve your emergencies.
- You do not compromise your savings to resolve emergencies.
- You learn to manage money better in the short, medium, and long term, which has a positive impact on your finances.
Protect your finances with an emergency fund
Without a doubt, having an emergency fund will help you weather difficult times and face extraordinary expenses without breaking the bank or falling into debt.
Furthermore, this reserve of cash keeps you away from financial crises that could harm your assets in the long term, which should give you an idea of its validity and relevance.
