5 reasons you must have an emergency fund and how to build it

An emergency fund comes in handy for many unexpected life events, and you will thank yourself many times over for setting one up.

Think of an emergency fund as your financial safety net. Ultimately your emergency fund should be enough to cover most emergency expenses and basic needs for several months (i.e., housing, food, utilities, childcare, medical costs).

If you are looking for some convincing to start your emergency fund, here are a few reasons to push you along your way.

Why you need an emergency fund

1. A rainy day umbrella

The first reason is a catch-all. Almost by definition, an emergency fund prepares you for the unexpected. This rainy day might present itself as a medical emergency, loss of employment, a pandemic, or even when your car breaks down. If and when that rainy day comes, you will be glad you have an umbrella to keep you moving.

2. Home ownership

More than 90 per cent of Singaporeans are homeowners. If you are a new HDB flat homeowner, you already know the many different monthly expenses and taxes you pay every year. That being said, it is harder to imagine your new shiny home needing regular maintenance.

Whether it is furniture, your floors, or your kitchen appliances, normal wear and tear will mean forking up some extra cash. Instead of pulling out your credit card every time something needs fixing, having an emergency fund to address unexpected maintenance costs is a must.

3. Paying off debt

If you are in the process of paying off a home loan, personal loan, or some credit card debt, the last thing you want to do is go into further debt. You will end up paying much more in interest, and every bump in the road will keep stacking up on top of each other.

Help yourself focus on getting yourself debt-free by setting aside some cash for an emergency fund. The fund will give you a bit more financial security along with a small buffer between your monthly living expenses and your debt.

4. Self-employed

If you are self-employed or plan to be self-employed, having an emergency fund protects you against the ups and downs of your annual income.

Many freelancers and young professionals work contract to contract. There can be some gaps between jobs, and having an emergency fund can function to fill in those gaps. One of the most common uses of an emergency fund is to supplement income, which brings us to our final reason.

5. Single-income household

Are you a single-income household? Although the financial risk varies from family to household, the fact of the matter is that you have multiple people depending on one source of income. No matter how secure your career or profession, delays or even losing that source of income is devastating.

Having a three- to six-month emergency fund to stabilise yourself and your family can give you enough time to apply, interview, and find a new job to replace lost income.

How to start an emergency fund

1. Set up a separate account

To keep your emergency fund apart from your spending account, it’s best to create a separate account where your emergency funds are immediately accessible, like a high-interest savings account or a regular savings account. That way, you can keep track of your expenditure and only allow yourself to dip into your emergency funds when necessary.

2. Set aside 3-6 months’ worth of expenses

Emergency funds should be enough to cover you and your family’s living expenses for at least three to six months, although you can certainly set aside more if you’d prefer.

This fund should cover all essential expenses like utility bills, food, transport, and recurring payments like insurance premiums, instalments, and the like. These should not include discretionary spending like travel, shopping, fine dining, and other lifestyle luxuries.

3. Establish some rules

An emergency fund should only be used for emergencies, so you need to create rules and definitions for an emergency to avoid treating it like any other checking account that you can easily tap into.

Emergency situations include situations where you might have to pay an unexpected medical fee, car repair costs, or if you are retrenched, and so on.

4. Replenish used funds as soon as possible

Your emergency fund has a specific purpose: to tide you through times of emergency. Therefore, as soon as that period is over and you are no longer in need of extra financial support, you should replenish your emergency funds. You can do this by earning extra income with a supplementary job or side hustle, or saving a little extra each month.

Although an emergency fund may feel like any other savings account, it is not. You are not putting away money into this fund for a major purchase down the road. It is a pile of cash that you will want around when you need it most. Therefore, set yourself some conservative guidelines and expectations.

ALSO READ: 4 key questions to ask yourself before signing up for a credit card

This article was first published in ValueChampion.