One of the most important steps in financial planning is to set up an emergency fund. Based on what I learned from IMG, setting up an emergency fund is the fifth step in building a solid financial foundation. I want to share here five things to ask about emergency fund, so that we will know why emergency fund is important in order to achieve financial freedom.
1. Why should you need to set up an emergency fund?
We all knew that emergencies really happen but few of us prepare for it. It doesn’t mean that if you are creating emergency fund, you are expecting emergency in your life. But it is better to be ready because most of the time emergencies cost a lot of money such as job loss, major damages or repairs for homes, business properties, cars, etc., illness in the family, disaster or fortuitous events and others. Among these reasons, the most common reason why we need to set up an emergency fund is JOB LOSS. Job security is the thing of the past. The saddest part of it, many Filipinos do not realize it.
From the book of Mr. Randell Tiongson’s Money Manifesto, he shared three reasons why we should set up an emergency fund. I wanna share these three reasons also to you.
a. Emergencies do happen – It is foolish to think that emergencies will not happen to you. As time goes on, you realize that things do come up that you have not planned for, and you’re going to have to provide for them. Things do happen, and they won’t happen at a convenient time.
b. Relieve stress – Having an emergency fund has an added bonus – peace of mind! You will feel relieved because you no longer have to worry about most small emergencies. Once you get your larger emergency fund saved, you won’t have to worry about paying for most large ones either.
c. Risk reduction – When you have established an emergency fund (along with other important things like fire insurance, non-life insurance and health insurance), you have a lot less risk of unfortunate things happening. You will also be less likely to go into debt. In others words, you’re making sound decisions to plan for problems before they actually happen.
2. How much emergency fund do we need?
I learned from IMG that we should set aside 3-6 months of our salary to help cope with emergencies and unexpected changes. However, for me, my emergency fund is based on my monthly expenses. For example, you are earning P50,000 a month but you only spend P20,000 a month, so the difference of P30,000 can be invested so that it will earn interest. But only after you have created your emergency fund first. Always remember that. Before starting creating an emergency fund, it is best if you know how much you actually spend in a month. That’s why it is really important to record your expenses daily so that you know how much you are going to save for it. The rule of thumb for emergency fund is three to six months of your monthly expenses.
3. How are you going to create an emergency fund?
I know that it’s hard to create an emergency fund at first but you just have to do it. Why? Go back to No. 1 question. What I did when I started saving for my emergency fund is I set aside 5% of my salary every cut off and every time I received incentive from IMG weekly. You may follow what I did; you may start at 1%, then 3% and so forth. You may also set aside fixed amount every month like start at 200, then 500 and so forth. Dave Ramsey suggests we do it by “baby steps”. Set aside little money regularly into an emergency fund. Do it in stages like one week’s worth of expenses first, and then move to two weeks, to three weeks, and so forth. You will notice later on, you have developed the habit of saving money.
4. Where are you going to put your emergency fund?
When I learned from IMG that emergency fund is vital to building a solid financial foundation, I decided to open a separate bank account specifically for my emergency fund. I enrolled it online so that every time I received my salary and incentive from IMG, I just transferred the amount to my emergency fund savings account equivalent to 5% of the amount I received. If you are comfortable with managing multiple accounts, a separate savings account for your emergency fund is a good idea like what I did. You may also keep a piggy bank or an envelope for you to put your cash in. Then once the amount reaches P1,000 to P5,000, you may deposit it to your savings account that is dedicated for your emergency fund only. So it is highly recommended that you put your emergency fund in savings account so that you can access it anytime in case of emergency. However, I learned from Mr. Randell Tiongson that you may keep some of those emergency funds in cash; maybe one month’ worth as you may have difficulty in accessing your bank in sudden emergencies like disaster or calamities. He said also that it is not recommended that you invest your emergency fund but you may park some of these emergency funds to time deposit to realize some earnings. Just make sure that it can be withdrawn quickly and without huge penalties. Remember that this fund is for real emergency only and when you use it you have to replenish it again. You can be creative here as long as you will end up at the same goal – that is to have an emergency fund.
5. Why should you need to have emergency fund before making an investment?
In building a solid financial foundation, before investing to mutual fund, real estate, stocks and other volatile instruments, we should have emergency fund first because our goal for investment is long-term, right? We do not want to interrupt the growth of our investment every time there is a sudden emergency. Sometimes we just need to use our common sense so that we won’t end up broke or ignorant. I have always been an advocate of financial literacy and I believe that education is really important before making any investment. I believe that we should invest first to our own education to gain financial knowledge.
Randell Tiongson said that the financial education of many Filipinos (though improving) is still far from ideal, and many of our brothers are misguided with regards to handling money. I am proud that I am part of IMG’s Global Campaign of Financial Literacy. I wanna help many Filipinos around the globe get financially educated. I hope you learn something from this blog and to know more about it, click this link and REGISTER TO FREE FINANCIAL CLASS!
You have a Millionaire Mind, Pinoy! Let’s use it.
Cheers to our success!