6 steps to building an emergency fund
Using emergency savings to cover unforeseen expenses is better than paying for them by taking out a loan. Here’s how you can start building an emergency fund.
If there’s one thing life has taught us, is that it happens. This is because we never know what is going to come our way (read accidents, pandemics, job losses). It is therefore important to have a buffer between you and the ever-constant curveballs. An emergency fund acts as a safety net that helps you turn a would-be huge life crisis into a slight inconvenience.
An emergency fund is money that’s set aside for unplanned expenses such as medical bills, home repairs or loss of income. Using emergency savings to cover unforeseen expenses is better than paying for them by taking out a loan.
Personal finance consultant, David Ramsey, recommends saving a starter emergency fund of $1,000 (KSh113, 700) first especially if you have consumer debt. Ramsey adds that once you’re out of debt, it is time to build up that amount and save three to six months of expenses in a fully funded emergency fund. Saving that amount may take a while, so make small goals at first, then work your way up to a reserve.
Strive to have a liquid emergency fund. This means you need to keep the fund in a place where you can quickly and easily access it. Also try to separate it from your other bank accounts as this minimizes the temptation of dipping your fingers into it.
The best options for an emergency fund are:
- A money market account that comes with a debit card or check-writing privileges rendering it convenient.
- Certificates of Deposit (CDs). These are different from other options because they require you to keep your money in the account for a specific period of time in exchange for receiving a guaranteed rate of return. This could be for as short as a month or as long as five or more years.
- A simple savings account that is connected to your checking account.
- An online bank that pays a higher interest rate and where you can still transfer money quickly and directly to your checking account.
Having an emergency fund keeps you prepared for life’s twists and turns and here’s how you can do it:
1. Make a budget and be consistent
A budget helps you have a full picture of where your money goes every month. Ensure that your budget is realistic and decide how much will go where and how often.
2. Set a monthly savings goal
Coming up with a savings goal or a reason for saving will keep you on your toes to not spend your savings and keep building your emergency fund. Your goals may be short-term or long-term, just tie them to the fund and be consistent.
3. Keep saving after reaching your goal
In case you surpass your emergency fund target, keep saving as some emergencies may require more than a six-month cushion. It is better to have more than you need than none.
4. Automate your savings
In banking, a direct deposit refers to the deposit of funds electronically into a bank account rather than through a physical, paper cheque. Automating the process can help you save regularly as it eliminates the temptation of spending by putting the money directly into your emergency fund.
5. Gradually increase your savings
Over time, strive to increase the amount you’re contributing to your emergency fund by a specific amount until you reach your savings goal. Increasing the amount gradually will help make changes to your checking account balance less noticeable.
6. Don’t increase your monthly spending
Don’t be lulled into a false sense of financial security because you have been saving for a while. Be realistic and don’t let new spending creep up again as having a substantial emergency fund is critical to your financial well-being.