#11 – How to Set Up Your 2 Essential Emergency Funds
Today a super important episode on emergency funds. Setting up your 2 essential emergency funds is an incredibly powerful strategy to create a financial safety net, avoid debt and make sure you don’t need into your other savings to deal with emergencies.
After listening to this episode you’ll know:
- Why having emergency funds is so important
- The two types of emergency funds you need to set up
- How to start funding both funds
The full transcript can be found at the bottom of the show notes.
Read the Transcript
Hello and welcome to another episode of the Financial Harmoney Podcast. This is episode number 11: How to set up your 2 essential emergency funds.
So today I want to talk about the topic of Emergency Funds. An incredibly powerful strategy to build a safety net around your personal finances and prevent emergencies from hijacking your financial life or your financial harmony. I like to divide emergency funds into two types, which we’ll go into in this episode. And then I want to give some tips on how to build your own emergency funds.
Let’s start off with what an emergency fund is. It is a very simple, yet very effective concept. And if you’ve never heard of emergency funds before, the simplicity might amaze you and you might at the end of this episode wonder why you had never thought of setting up an emergency fund yourself. That at least is what I felt when I first found out about emergency funds.
An emergency fund is money that you have in a separate account that you have specifically set aside to deal with emergencies. The brilliance of having emergency money is that when you are faced with an emergency, you don’t need to go into debt in order to pay for the associated costs of said emergency. Nor do you need to dip into your savings for your next holiday or the savings you have to pursue your dream.
Even if we can’t predict what emergency might hit us, what we can with some certainty predict is that from time to time we will experience some type of emergency. Wouldn’t it be nice to know that come what may, at least we have some money set aside to deal with it.
As I said at the beginning, I distinguish between two different types of emergency funds. The first one is an emergency fund to deal with unexpected expenses. Let me give you some examples of what these unexpected expenses might be.
Your car needing an emergency repair
Your washing machine breaking down beyond repair and needing to be replaced
A plumbing issue in your house
A medical or dental emergency
Your pet needing an emergency treatment or operation
Or a last minute flight ticket to attend a funeral
These are just some examples, and they are not uncommon unfortunately. The thing is, you never know when they are going to happen, but I can guarantee that from time to time, one of these types of emergencies will happen. As you can’t prepare for the emergency itself, at least you can make sure that you have some money set aside in order to be able to deal with the circumstance.
See how this is a brilliant yet very simple way to protect yourself from going into debt or using your other savings and setting you back on those goals whenever you face unexpected calamities. Another really powerful advantage of an emergency fund is not just the financial advantage. It is also the emotional advantage, and I mean the peace of mind knowing that you can deal with these emergencies, at least financially speaking. And when they do happen, you don’t need to stress about where on earth you’re going to find the money to be able to pay for whatever is happening.
Now how much do I recommend you set aside in an emergency fund? This of course depends a little bit on your personal situation. A relatively common figure to work off is $1,000, €1,000 or £1,000 or the equivalent for your currency. But you might want to increase this to 1,5 or 2 thousand dollars. I used to have €1,000 set aside, but I have recently increased this to €2,000. I’ve done this for two reasons. First of all, I now have 5 pets, 3 dogs and 2 cats, and the risk of one of them needing some type of emergency or an expensive treatment has increased compared to when I had “just” in inverted commas 1 dog and 2 cats several years ago, who were by then also a few years younger still.
Another reason I have increased my emergency savings is that I live in Spain, but my family and friends live mostly in the Netherlands whereas my in-laws live in the UK. While a few hundred euros would have been enough pre-covid times to get last minute tickets for both me and my husband to one of our own countries if that were ever needed, the current travel requirements and occasional suspension of air travel between certain countries, have made me feel more nervous about potential difficulties to go abroad. I’m not talking about hiring a private yet to get me from here to where I might need to be, but if I can only travel by road for example and need to take several covid tests along the way and pay for last minute overnight hotel stays and food to get me home, then at least I have the money set aside to do so if that were still possible.
So how much you need in your emergency fund is really dependent on your personal situation. If starting from 0, then build it up to $500 first, then to $1,000 and with time build it out to maybe $1,500 or $2,000.
Whenever you need to use this emergency money, and remember this is just for emergencies, so it isn’t for something you want to do and wish you had money for, it really is to cover essential expenses that come up unexpectedly and that you can’t ignore. So whenever you do use this money, make sure to top it back up again as soon as is realistically viable.
So that is the first type of emergency fund that I recommend you have and I generally see this as a goal that should be high up on your financial priorities list.
A second type of emergency fund I recommend you start building is a 3 – 6 months expenses fund. That means the amount of money you need in order to cover between 3 and 6 months of your expenses. Now why might you need such a big second emergency fund? The objective of this fund is to be able to pay your bills in case you lost your income. There are different reasons you might lose your income. Such as the loss of your job, you might get fired. Or if you have your own company, you might lose all of your clients. You might also take time off work to care for an ill family member. Or you might decide to leave your job if you no longer enjoy working there. And lastly, a 6 months expenses fund is also a really important prerequisite to have if you are starting your own business. You’ll probably need time to build this business and get paying customers to replace your original income. So having 6 months set aside to cover your bills, takes at least some of that pressure off you and will allow you to focus on growing your business during that time.
As you can imagine, we’re talking about a lot more money for this emergency fund than for the first one. The exact amount of money you want to have in this fund depends once again on your own situation. But I’ll give you some pointers to help you decide how much to put into this fund.
If you are a two income household with a steady job and if you and your partner would likely be able to find a new job quickly, you might need less than if you are a single earner, self employed or will find it harder to find a new job.
Also if you can and want to quickly cut out certain expenses, such as memberships or even monthly saving contributions, you might need less in this fund than if you can’t or don’t want to make cuts in your expenses. Now I am not saying that you want to stop making savings contributions, but if you need to start somewhere, you could begin with saving up the core essential expenses first, the ones that you really can’t cut out.
And once again, if you are in a two person household, the way you organize your finances might decide how much to put into this emergency fund. This will be different if you share all bills compared to if you both make specific contributions to certain bills or to a joint checking account. Decide whether you want to cover both of your incomes, or just the one for the highest earner in your household. In my situation, I run a company together with my husband, so it makes sense for us to have an emergency account that could cover all of our expenses, just in case our company goes bust and we’re both without an income.
This second emergency fund is obviously a much more long-term goal compared to the first emergency fund as it requires more money. This is okay, but don’t let this deter you from taking action. Just start and begin working towards 1 month of emergency expenses first.
Now that we’ve spoken about the two types of emergency funds that I recommend you create, you might be wondering where to store this money. Well I highly recommend a separate account for these funds, so that you won’t get tempted to use this money. This is for emergencies only, so having it separate from any other savings accounts, as well as from your regular checking account, creates an extra level of security let’s say that you won’t just dip into this money whenever you fancy. It’s important that you make sure that the account that you set up for this is a fee-free one so that you don’t waste money on maintenance fees or card fees for example, as you will not be using this account very much – hopefully – and you don’t want to be losing money here.
Now, the last thing I want to address in this episode is how you can save together the money for both these funds. I recommend you start with the first one first. So don’t bother putting aside money for your 3 – 6 months expenses fund, until you have your first emergency fund fully funded. Decide how much you want to have in that first account, as said the equivalent of say $500 or $1,000 is a good amount to start with. Then try and speed-save this one where possible. So some things you can do to help you, include:
Using a tax refund if you get one
Or making some extra money with extra hours at work or a temporal part-time job
You can also organize a yard or car boot sale. So clear out your garage or attic, and make some extra money whilst at the same time tidying up your house.
Or you can set yourself a 30 day challenge to cut out one expense for the next 30 days and see how much money you can save.
With regards to your bigger emergency fund, so that’s the 3 – 6 months expenses fund, I recommend you set a monthly savings target for this goal and set up an automatic transfer at the start of each month into this savings account. As this one will take you longer to save up for, you want to make sure this process is as easy as possible so having an automatic monthly payment going into this fund is the best way to ensure that you keep this at the top of your priority list.
And that gets us to the end of this episode. I hope you feel inspired to start your own emergency fund now that you know why these can be really important to have. And don’t forget not to stress if this takes you a little while to get the required money for both these funds together. Remember that any progress you make, however small, is better than no progress at all.
So that was it, the end of this episode of the Financial Harmoney Podcast – How to set up your 2 essential emergency funds. I hope you enjoyed it, make sure to subscribe and I’ll see you next time.