What is an Emergency Fund and Why You Need One

Remember that day you were driving to a remote area on a rocky road and the car broke down, leaving you stranded and with unexpected repair costs? Or maybe your child fell sick and you had to take them to the hospital hurriedly, and you had to fork out some cash you had not budgeted for?

You did not anticipate that incident, did you? I am guessing that your answer is no and it probably set you back on a lot of cash, trying to get yourself out of that challenge. You might have even phoned a couple of friends to get them to loan you some cash. 

On a more general example, no one had foreseen a global pandemic knocking on our doors a year and a half ago. All the job losses that happened, house evictions, loss of incomes; it was all not anticipated.

Covid-19 has shown people the importance of having an emergency fund which you can turn to whenever you are in financial distress. Since the pandemic, coming up with money to cover major expenses has been quite the challenge for most people in Kenya.

What is an Emergency Fund?

It is money that has been put away that people can make use of when they are in financial distress. The objective of having an emergency fund is to improve one’s financial security by creating a safety net which can be utilised to meet unanticipated expenses, like a sickness or major car repairs or unemployment. Having an emergency fund reduces the need to go for high-interest debt options, like shylocks or unsecured loans.

How to Build an Emergency Fund

1. Have a target
   

This can be done by calculating how much you will need for a period of time, say 6 months.

Have it stipulated to the most minute detail so that every need is catered for in the total figure.

2. Set a proportion to save from your income
   

One of the ways to do this is by transferring money to your emergency fund every

time you get your paycheck. Doing this will develop, in you, the habit of saving regularly and will make the saving less daunting.

3. Automatically move money into your savings account

If your employer allows direct deposit, then it is possible that they can divide your salary between multiple checking and your savings accounts so that your monthly savings is done without having to touch your account.

4. Have a piggy bank
   

Piggy banks can also be used for grownups. You could save up the change you receive from regular shopping etc. Like when you go to the supermarket and they give you Ksh5 coins as change. You don’t have to dispose of them. Save them up then deposit them in your savings account when the piggy is full. A personal favourite for me, is the rarer Ksh40 coin, that I always ask for if the change is in that region. I probably have 200 of these coins by now - that’s a cool Ksh8,000 I have saved up in what is really a fun activity for me. 

5. Save your tax refund
   

While filing your taxes, consider getting your refund deposited directly into your emergency fund.

6. Assess and adjust contributions
   

Check on the health of your account after a few months just to see how much you’ve saved, and adjust if you are able or if needed, especially if you recently have withdrawn money from your emergency fund. Also consider investing any additional income if you’ve saved up enough to cover six months of expenses and have extra cash.

When to Use Your Emergency Fund

Sometimes, it may be tempting to use these funds toward a holiday, paying off some debts, making a downpayment on a new home or another significant expense that may occur, it’s important to create a list of expenses that are acceptable for things that this money has been designated for. They should be true emergencies - things such as medical emergencies, covering your living costs during unemployment periods, paying for repairs to your home as a result of a natural calamity or a fire, emergency veterinarian bills, and unforeseen vehicle repairs. 

The whole aim of an emergency fund is to prevent you from adding on to your debt in times of need. It should also allow you to absorb any shocks resulting from unexpected events. If say, you are laid off, an emergency fund that covers up to six months of monthly expenses will allow you to get back on your feet faster.

You, definitely, would want to ensure that this money is safely stored in your account and it should be easily accessible for those occasions when you need it. Further, putting it in a bank can help it grow on its own, by earning interest.

Reasons You Need an Emergency Fund

1. You're Trying to Pay Off Debt
   

An emergency fund can help us stop adding to our debts with every financial challenge encountered. It can help in covering for the things you haven’t budgeted for, like vehicle repairs or medical expenses. You can use it to handle these very stressful events and make it better and easier for you to stay focused on your path to get out of debt.

2. You Just Started Budgeting
   

When you first begin budgeting, you may be unconsciously leaving out some of the very important expenses that need planning for. The fund is able to cover some of the expenses the first year, then you can proceed to add those expenses into your budget as they arise. These could be expenses like fees for organizations.

    3. You Only Have One Income Stream

If you only have one job, it means you have one source of income. It is important to have a substantial emergency fund. This could help to get through an illness that keeps the primary breadwinner from working or an unexpected job loss. Having, at least, a six months’ worth of expenses in your emergency would cushion you in case the unthinkable happens.

4. You Are Self-Employed or a Contractor
   

Being self-employed or an independent contractor, or if you are working a fixed term contract job, it is important to have a sufficient emergency fund in place. Also, if you realize that the contract may end soon, you may want to work on saving up more money in your emergency fund.

5. You Own Your Home
   

Owning a home, you’ll have to pay any necessary repairs and maintenance. Even though you usually set up a fund to cater for remodeling and repairs, unexpected costs like a repair in the plumbing system may occur. Your emergency fund can make owning a home a little bit less stressful.  

6. You Live Far Away from Family
   

If you live abroad, it can be quite expensive to travel back home, and the costs go much higher if you need to travel urgently for an emergency. Having a good emergency fund saved up helps to cover the cost of last-minute tickets to travel home in the event of a funeral or a medical emergency.  

7. You Have Medical Issues
   

Having a serious medical condition can be draining, and cause you to wipe out your hospital insurance each year. Also, some routine tests could add up quickly or need to use all of your sick leave days, and you end up taking days off with no pay. A good size emergency fund can help you through these costs and make it easier to get through these challenging moments.  

8. You're Saving for a Goal
   

If you have a set financial target and are saving towards it, your emergency fund can prevent you from digging into those savings when unanticipated costs arise. This will help to not be pushed steps behind on your path towards your goal.

WRAPPING UP

However challenging it may seem or maybe even pointless to live below your means, you will probably be happier that you did save up when that emergency happens and the overall impact on your financial health is minimal. You can only depend on yourself to get out of trouble. Bad things may happen to anyone, and working on your financial health should be a priority just as well as working on your physical health is.