Whether we like it or not, emergencies happen, and often when we least expect them. But while we can’t always predict or prevent crises, we can definitely prepare for them in advance.
A tire that bursts, a home appliance that malfunctions, or a minor injury that needs immediate treatment may hurt but not deplete your purse. However, there are dire situations that can literally empty one’s pocket, such as a serious health issue, loss of employment, or a failed business venture. In these instances, an emergency fund will be most useful.
Randell Tiongson, a registered financial planner, wrote in his book No Nonsense Personal Finance that building an emergency fund is ideally done simultaneously with improving your cash flow (finding ways to earn more and spend less) and getting out of debt as much as your resources permit.
He adds that to build a proper emergency fund, it is essential to know just how much you actually spend in a month. Consider all your expenses, check your bills, and record your spending to get a good estimate.
The rule of thumb for creating an emergency allocation, he says, is to put aside an amount between three and six months’ worth of your monthly expenses.
“Three months is good, four months is better, five months will be great, and six months is excellent,” says Tiongson.
He adds that the most common reason to build an emergency fund is to cover a potential sudden loss of income. “I have given countless seminars to employees who went through retrenchment, and the common occurrence among them is that despite their stellar performance, they still lost their jobs,” adds Tiongson.
He also reminds people to exercise wisdom when determining what a real emergency is. “A 42-inch flat LED TV, a laptop, or designer bags and shoes that are on sale is definitely not an emergency—no matter how you justify it!” he emphasizes.
Here, Tiongson enumerates three good reasons to set up an emergency fund:
- To prepare. It is wishful thinking to say that you won’t be badly affected by crises in the future. As you get older, you’ll come across unplanned substantial expenses and bills that you will have to settle.
- To have peace of mind. Having an emergency fund will minimize your stress and worries when something untoward does happen.
- To reduce risks. With an established emergency fund, backed by life, non-life, health, and other insurance plans, you may be able to avert indebtedness or even total financial ruin in case of a major setback.
The good news is, as you plan ahead for adverse events that may happen in the future, you develop the skill for making sound decisions that will have a long-term benefit on your life. – Ruth Manimtim-Floresca