How to Build a Durable Emergency Fund to Weather Financial Storms

Have you had a financial emergency recently? Or perhaps in the past? We’ve all been there before.  What an uncomfortable place to be in.  We had to resort to borrowing, or lean on family members and friends for a bailout.  But all we had to do to climb out from that pit, was use emergency savings – we had previously socked away in an emergency fund.

A typical emergency fund is built by creating  a 3 to 6 month financial runway.  Calculate upto 6 months of living expenses that will come in hand in the event of an emergency.  Invest this is a high yield savings account for both liquidity and a fair amount of interest growth over time.

What is an Emergency Fund?

An Emergency Fund is a contingency hoard of cash (or its equivalents) to bail you out of unforeseen financial mishaps.  These emergencies or inconveniences happen to all of us at one point in our lives or another.

Many unplanned expenses may occur in your life, but not all of them could be classified as emergencies.  We’re typically looking at medical expenses – that cannot be postponed; home repair expenses, job loss, or even disability or sudden death in the family.  Other events may count, but we have to draw the line somewhere.

The Need for Emergency Funds

An emergency fund exists to give a person, couples, or a family financial relief in the event of a money crisis.  This rainy day emergency savings provides a cushion if not a total solution for that discomfort.

The saver parks cash on a regular basis until they reach a 6 month living expense threshold. You can’t find a better plan or strategy to any financial mess than the ideas and tips listed here.

From a modern approach, build an emergency fund that is suited and tailored to your personal finance needs.  A resource to utilize to during financial hardships to prevent you from touching your investment nest egg you’ve been compounding for wealth and perhaps early retirement.

Start Building an Emergency Fund now

There is no time to wait.  The best time to implement such an essential financial tool was yesterday.  The second best time is today.  Now!  Do you have a paper? Just list a mini plan with a small to-do list to get the ball rolling.  Nowadays it’s even easier using your device.

If you’re already in a financial predicament as you read this, it would be a lot better to deal with it before you start building this relief fund.  This is because you’ll have very little room to make meaningful adjustments to your current budget.  Can you accommodate the extra burden of making special cash savings into a new financial contingency account?

Turn it into a fun game

Like everything else in finance or math – for that matter, a game-like mentality will take the fear out of managing your money.  Inject some fun into this activity.  You’ll need to go slow if you feel the need to, then go hard if you’re inclined to.  Keep score and review everything you do on a regular basis.

The Anatomy of an Emergency Fund

The basic implementation of an ideal emergency fund requires no financial or accounting background.  The various parts and components are simple to identify and implement. Here, you have a mini to-do list of steps that will keep all the bases covered.  But don’t expect everything to be perfect on the first try.  It takes time to get the rhythm going.  Just ease into it slowly and optimize as you go along.  Use the list below as general outline:

1. Purpose of your Emergency Fund
2. How much you should have in this fund
3. Where to stash your Emergency Fund
4. When and how to withdraw funds

1) Purpose of an Emergency Fund

Here are a list of personal financial goals and objectives for a typical emergency fund.  You will be saving money continuously towards these events that will occur in the near or distant future.

• Unplanned Expenses
• Medical Expenses
• Home Repair Expenses
• Car Repairs
• Job Loss
• Financial Plan Component
• Avoid Taking More Loans
• Avoid Raiding Your Investments
• Sudden Death or Disability In Family

2) How much should I have in my emergency fund?

As a rule of thumb, make sure you have at least six (6) months worth of living expenses saved up if you’re an individual.  Then it’s also recommended to scale it up to one (1) year if you have dependents. The minimal interest payments your account would receive may make up for inflation over time.  However if you live outside the US, you’ll need to adjust your savings deposits for inflation year-on-year.

Calculations (How to get your goal amount):

To keep things as basic as possible, calculate how much you spend in a month on the essential needs in your life.  If you’re using a budgeting system like the 50-30-20 Rule, it would be within the ball park of 50% of your after tax income.  For example, a $50K annual income would be:

$50,000 / 12 = $4,166.00 (monthly pre tax income)
Assuming a tax rate of 28.4% (average estimate => $1,183.14 in taxes)
Total After-Tax income = $2,982.85
50% of this is = $1,491.43
Finally, save up an emergency of: $1,491.43 x 6 months = $8,948.58 (round it off to $10K if you like)

Budgeting (How much to save each month):

Start saving just $100 a month for starters.  According to the 50-30-20 budget rule, with an estimated $50K annual income, you should be able to set aside $596.57 in your savings column of your budget for paying off debt, investing, etc.  This is a good place to begin your monthly deductions. Increase the monthly contributions from $100 to as much as 20% of your after-tax income. With a target sum of $10,000 (a 20% of the $50,000 pre-tax annual income example above) to accumulate, you will need to save for 8 and a half years ($100 X 100 months = $10K); or save all 20% of after-tax income of $596.57.  That should require only a year and a half of monthly savings ($596.57 x 16.76 months = $10K).

You’ll have to treat this monthly payment as an essential expense.  As important as a utility or housing payment.  Throw in your wind-falls and unexpected incomes and bonuses just to give you a head start.

Eligible Items of Your Living Expenses (must-haves needs list)

When constructing your emergency fund, please  note that you’ll have to do adjustments to the Expenses Column of your budget (much clearer if you’re using the 50-30-20 Rule Budget).  Make sure they are true essentials you can’t live without:

• Rent or Mortgage Payments
• Utilities
• Basic groceries
• Health Care
• Insurance Premiums
• Child Care / Tuition
• Transportation
• Minimum Debt Payments (credit cards, car loans, student loans)

Ineligible Items of Your Living Expenses (nice-to-haves wants list)

These items can be omitted.  They are important to you.  But you can do without them for a while until you complete the accumulation of your rainy day emergency fund.

• Entertainment
• Restaurant Meals
• Vacations
• Gym Memberships
• Discretionary Groceries

3) Where To Stash Your Emergency Fund

High Yield Savings Account

This is a common destination of many contingency funds due to easy access of funds when needed in an emergency, and also gives competitive yield above your standard savings account.  A lot of Online Bank Accounts have a High Yield Savings Account product for you to check out.

Ensure that your deposits are insured by dealing with Banks or equivalent financial institutions that are FDIC or NCUA complaint.

Money Market Accounts or Funds

This are similar to High Yield Savings accounts but they offer you slightly better returns on our money.  You many also have a check book issued along with a convenient debit card also.

Certificates of Deposits (CDs)

Money for emergencies can be placed at term to gain a predetermined interest rate at the end of a give investment cycle.  You can cash out of reinvest until you need the funds for your purpose.  But look out for penalties for early withdrawals.

Sage Tip:  When should you start an emergency fund?

Roth IRAs

This Individual Retirement Account with its tax free withdrawal advantages could be a good fit for your emergency fund plans.  Learn more on how to use your Roth IRA as an Emergency Fund.

Mutual Funds & ETFs

These are not recommended for emergency funds due to their volatility.  But could potentially have significant advantage for the strategic investor.  If you allocate a sizable portion of the emergency fund to these asset classes, you could see a faster yield altogether.  It will probably take you less time to reach your goal amount than the individual who didn’t add in this diversification.  You could also potentially see your rainy day fund amount fall in bear markets and it may not recover in time to meet the needs of your next financial emergency.

Read next: How to Invest $50 000 in Stocks for Above Average Returns

4) When And How To Withdraw Funds

You can access cash from your emergency fund in a number of ways.  But be sure to replenish it systematically each time to restore it to its original goal amount.  This will give you a dependable strategy for weathering the economic storms of life.

Withdrawing Monthly Payments

You may take out the amount you need to cover the unexpected expense, or draw out money in installments or automatic payments in the event of a job loss.   This will give you the spending range of up to the time the fund runs out, or that financial issue is solved.

Withdrawing Larger Sums For Big One-Off Payments

This is your personal insurance bailout plan.  Larger unexpected expense such as a trip to the ER, a home repair after a heavy storm, etc.  Your fund should cover these costs.  Without such a cash cushion in hand, you’d have to resort to borrowing, leading to more debt consequences down the road.

Strategic Credit Synchronization

I just made up this term -;)  it’s a straight forward strategy a lot of people use with their emergency fund.  In the event of a financial crisis which requires a lump sum, you can use your credit card.  This is gives you a convenience of speed, and yet you can avoid the huge interest bill by paying it off quickly it funds accumulated an emergency fund account.  This will come in handy if your emergency savings withdrawals require an unbearable waiting period before accessing cash.

Advanced Strategies for Emergency Funds

Many advanced strategies exist in creating and managing an emergency fund.  You can have one or more of the following:

A liquid position – slow growth but reliable with regard to risk and delivery upon short notice.  As mentioned above with regard to High Yield Savings accounts, Money Market Accounts, Certificates of Deposits.  This can be used alongside non-liquid positions – that produce faster growth to get you to your minimum 6 month accumulation goal, but funds may be subject to supply tensions and capital market fluctuations.

How to grow your emergency fund – Grow your emergency savings deposits using windfalls, unexpected income, bonuses, cash from side hustles and more.  The fund itself grows much faster over time if you don’t experience any financial crisis in economic downturns.  As assets or market indexes become much cheaper, you may move a little cash into a major US index fund – that looks like it’s bottomed out.  As risky as it may sound, the recovery process will produce growth in your holdings over time.

The New Dawn Approach (NDA)

I’ll also call it The Financial Sage Approach. After looking at several ideas for setting up emergency funds, I noticed they had the same things in common.  There is absolutely nothing notably wrong with that the current recommendations out there.  As long as a strategy works, why change it?

But I know you’re open minded enough to learn a little more to get your fund to work better than the average contingency fund.

The problem with saving for unforeseen emergencies could create a thought magnetic mechanism that attract those ill events to you the more.  The more you plan for bad news, the more you’ll receive one.  As important an emergency fund might be, it is better to build an Opportunity Fund instead.

This option will open the mind to great investments opportunities (stocks, housing, etc) ahead that could be selling at a discount to their true (intrinsic) value.  Your opportunity fund should eventually make you rich, so you could care less about a little medical bill or a loss of a primary job or income.

Global Betterment Approach (GBA)

This strategy gives meaning to your emergency saving fund.  It gives you a sense of purpose.  You’re saving to make the world a better place – alongside your own personal finance hedging ambitions to protect your wealth.

While you build an emergency fund until you reach your goal sum, your typical 6 month accumulation plan could keep on growing and compounding over time if not used.  The interests and yield on top of your target amount could be giving away to charity.  You’ll create a perpetual giving pledge of year-on-year payments to a worthy cause that will give you fulfillment as you press into living an abundant life free of want.

Become a Millionaire with Your Emergency Fund

No one saw this coming.  An emergency fund exists to give you some payments, or lump sum cash out if-you- like in the event of a personal money woe.  How can this be a path that lead to growth in wealth?  What do I have in mind, you might ask?

The sheer money mindset discipline of accumulating emergency savings could be transmuted into a accumulating wealth concurrently also.  While your emergency fund is half way into reaching your goal sum (about 3 months in), begin to save and build a Financial Freedom Fund.  This is an investment fund or account that will assure your financial freedom and early retirement.  You’ll either wean yourself off a full time job completely, or switch otherwise to a labor of love – doing only work that bring you fulfillment.

The Downsides and Drawbacks of an Emergency Fund

You can find all the pros listed above.  There could me a few cons unlisted that are worth mentioning.  An emergency fund can’t do any serious damage to you financial health – just to get that out of the way.

But it could certainly have a couple of drawbacks.  Let’s get into these:

Delay in building a real Financial Freedom Fund

If you stick solely to constructing an emergency fund without piling up investments, you may lose out big time in bull market opportunities, or even bear market opportunities also.  Some people like to postpone setting up a investment fund.  They feel the need to clear the relief fund first, so end up living a cycle of save-for-emergency > withdraw-a-payment > save-again-to-replenish.  They never seem to break out of that loop.

So do both at the same time.  Save a maximum amount threshold that you could allocate on your budget for building an emergency fund quickly, but as you hit mid-way (3 months), break the savings into two (2) parts and use the other half to build investments.  After reaching your emergency savings threshold in 6 months, use up those deposits to increase your investments.

Related Resource: Beginner’s Guide To Stocks: 10 Tips To Note Before You Invest

Slower payments on your debt settlements

While you save for a rainy day, do not leave your debts hanging.  Many people would suggest paying off your debt first, but I think you could do both.  Because any emergencies that may occur while paying off your debt could even lead you into more debt.  The worst thing you could do, is to shift your perspective from earning interests, to paying-interest.

A wrong focus on ill events

The final drawback in using emergency funds are that, you’ll attract what you focus on the most – especially those that are linked to your fears.  As mentioned previously in this article, the law of attraction will work to deliver the goal that is most linked to your strongest dominant emotion – the fear of a personal financial crisis.

So then focus on the positives.  You’re saving money to save money.  Your relief fund is earning you interests, and that feeling is a lot better than paying loan or credit card interests.  Ill events happen to all.  But the storm hits the hardest on those without a firm foundation of a crisis fund.

Sage Tip:  How to Learn About the Stock Market and Investing for Beginners

How To Overcome These Drawbacks

Create a mindset that loves learning new things.  You can have it both.  Start building your financial freedom fund alongside your emergency savings.  Let them work together for good according to the financial confidence that you keep building for your self.

The Bottom Line

An emergency fund very is paramount to your financial well being.  The process of compounding should be treated like a general expense of life you can’t possibly dispense with.  The accumulation of it should be seen as a store of hope.  An investment reservoir that would give you financial confidence to live life by your own terms.

Kept an emergency fund account previously? Have you used that cash for another purpose than it was meant for? Or how did you get out of your last money crisis? Your comments and contributions could be a wealth of encouragement and wisdom to other readers.  Please share.

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