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What is an emergency fund and how do you start one?

Emergency fund is the amount of money you have at your disposal whenever an emergency occurs. An emergency can be anything, ranging from a broken kitchen pipe, a medical expense, car repair, a  retrenchment, etc. In this world of uncertainties, especially in the year 2009, many things can happen. That is why one should always have an emergency fund – just in case.

But how much should you have? Some experts said 3 to 6 months of monthly expenses, while some even said 9 months to 1 year of expenses. In the end, it depends on you and your living lifestyle. Calculate the amount of debts or fixed expenses you have to pay in each month. They can be mortgages, study loans, food, rental, etc. The total amount will be your fixed expenses for 1 month. Now,  take that amount and make it 3 months to 6 months. For example, if your fixed expenses for 1 month is RM 1k, your emergency fund should be at least RM 3k. This is to ensure you can last for 3 months without any pay.

I know it’s not easy to have that amount of money all of a sudden. That is why you should start small. Get another savings account and pump the money in regularly. Only pump the extra money you have, after paying off your monthly fixed expenses. It could be 5% of your monthly pay, or 10% of your pay, whatever is comfortable for you. Start doing this every month and build up that emergency fund of yours. Preferably, that emergency fund should be inside an account which you don’t touch. You’ll defeat the purpose if you put your “emergency fund” somewhere but end up using it to buy something you WANT. Discipline is the key word here.

Once the amount has reached your so-called “target”, then you can look for other goals such as investment. Try to avoid touching your emergency fund at all cost and keep it as liquid as possible. Because in case there’s an emergency, you will want to take the money out as soon as possible, with the least damage or penalty incurred. In other words, you want it to be there when you need it. That’s why putting it into savings account is better than Fixed Deposit, stocks or bonds.

If you are very confident that there will not be any emergency in the near future, then you can take some of the emergency fund and pump it into low risk investment types such as Fixed Deposit. Make your money grow, without taking too much risk because if you don’t make it grow, it might become worthless few years down the road due to inflation.

That’s it! Simple right? It’s easier said than done actually. Remember that the key word here is DISCIPLINE. If you don’t have that, no amount of emergency fund will be able to save you when there’s really an emergency.

To summarize, here are the things you need to remember:

• Set up a target. How much do you need to survive without pay for 3 – 6 months? Take into account all your fixed expenses such as food, rentals, mortgages, loans.
• Start small. Deposit a little bit of your extra money into the emergency fund every month. The amount should not be significant as not to change your lifestyle.
• Put the money somewhere safe, somewhere isolated and somewhere you will definitely not touch. However, make it as liquid as possible so that you can take the money out without incurring any penalty or losses.
• Discipline. Your emergency fund should only be used for emergencies and not for you to buy that cool gadget.

That’s all from me. Hope it helps. Here are some articles which might be helpful for you.

• Why you need an emergency fund?
• Emergency cash – how to prepare with an emergency cash?
• How and why to start an emergency fund?

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