Why an emergency fund?

By Randell Tiongson on August 11th, 2013

Emergencies happen.

coin-jar-Emergency-fundThis fact remains unchanged, emergencies happen whether we like it or not. An emergency can be minuscule or it can be catastrophic. While we can handle small emergencies like changing the batteries of your tires, replacing a home appliance or a minor injury, some emergencies can be stressful. Major health breakdowns, loss of employment or business failure are some of the emergencies that we should prepare for.

It is foolish to think that we will never undergo an emergency in life and most of the time emergencies cost a lot of money. The third step in achieving financial peace is setting up your emergency fund.

Before starting on emergency fund, it is best if you know how much you actually spend in a month. Many people I know are clueless as to how much they spend monthly. During a financial planning session, I asked someone how much he spends monthly. He told me that he wasn’t sure as to the exact figure so he said he will just give me a ballpark figure. The figure he gave me was P40,000 to P80,000. If the discrepancy was about P5,000 to P10,000, it would have been understandable but P40,000? I politely asked the person to really think about all his expenses, examine his bills, record his spending and get back to me.

If you already have a monthly figure, you are now ready to start building your emergency fund. The rule of thumb for emergency allocation is somewhere between 3 to 6 months of your monthly expenses. 3 months is good, 4 months is better, 5 months will be great and 6 months is excellent. Emergency funds come in handy for a variety of reasons: medical emergencies, loss of employment, car breaking down, appliances needing sudden replacement, illness in the family and so forth and so forth. However, the most common reason for establishing your emergency fund is for a sudden loss of income. If you are an employee, there is no such thing as employment security anymore. Job security is actually a thing of the past. A very gainful employment can suddenly cease owing to the volatile nature of business and the economy. I have given countless seminars to employees who went through retrenchment for me to ignore the fact that losing a job, despite your stellar performance is now a common occurrence. Markets and the economy can have sudden changes and it is unfortunate that companies often see the need to downside just to remain profitable. For business owners, the risk of loss of income is likewise probably, if not more. Business ventures are speculative in nature therefore business failures do happen. I often advice entrepreneurs to set aside money for emergency funds just in case the business fails or when the business suffers temporary setbacks. Regardless of the nature of your employment or profession, an emergency fund is truly a prudent thing that we should all establish.

What is the best way to establish an emergency fund? It’s in Step 3 of No Nonsense Personal Finance: A Step by Step Guide. To order, CLICK HERE.

A prudent person foresees danger and takes precautions. The simpleton goes blindly on and suffers the consequences.” – Proverbs 27:12, NLT

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3 thoughts on “Why an emergency fund?”

  • Emergency fund is a must. It keep my finance life calm knowing that I have a fund to dip into whenever something is amiss.

    The good thing about having less expenses is that you only have to save small amount of emergency fund. I don’t have to save 300k for an emergency fund knowing that my monthly expenses is not greater than 2ok.

  • I always thought that having a minimum emergency fund and insurance is enough not until we experienced emergency first hand. Good thing my wife insisted that we keep a portion of our income for emergencies.

    After we experience our first ever emergency, we realized that nobody can predict when it could happen. That’s why we learned that there is no excuse not to prepare for it.

  • Having a base amount of money on hand adds a level of security even if you are in debt having 1 months living expenses on hand is helpful.

    I know the recommended is 6 months in a fund that doesn’t get touched but in reality we have found this hard to accomplish. Typically we will build up the reserve and then look at a debt whether it was student loan or mortgage and through the “emergency fund” at the debt. There may be a day where this bites use but I am way more passionate about paying off debt than I am about having what I consider a large reserve fund.

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Why an emergency fund?