5 Reasons Why You Need an Emergency Fund
Emergency savings is one important facet in planning your finances. Learn reasons why you need to save for your inevitable rainy days.
An emergency fund is a familiar term that is often stressed on by financial advisors when it comes to the best strategies to mitigate financial difficulties.
According to a survey conducted by the Department of Statistics Malaysia (DOSM) during the Movement Control Order (MCO) period last year, more than two-thirds (71.4%) of self-employed respondents had savings of less than a month’s worth and 82.7% of private-sector employees had savings of up to 2 months’ worth only.
If you don’t have an emergency fund in place and are hit by any of the unexpected financial situations, you will have to risk relying on credit cards, applying for a loan, or even using your retirement account. This would not be wise as it could lead you into much more debt or have insufficient money for your retirement years. Such actions lead to a lasting impact on your finances as they are harder to recover from than having built an emergency fund in the first place.
Before you start building an emergency fund, we outline to you 5 reasons why having one is important.
Reason #1. Relying On Active Income or Single Income
Having only active income or only one income source is familiar among us, especially those with monthly salaried basis. But, what if you face a situation that directly impacts your ability to make that income?
If you suddenly lost your job, the money will stop flowing in but you still must continue to cover your everyday expenses by using savings until you secure a new job. If 2020 has taught us something, it is that anything can happen and if you don’t have any savings, how will you pay for your commitments? The situation becomes even worse if you are the sole breadwinner of your family and it’s impossible to obtain money from another source of income as your condition keeps you from doing so.
For a single person, you should have at least 6 months of emergency savings to keep you afloat during these tough times. For an individual with dependents, it is recommended to have 6 to 12 months of emergency savings.
Reason #2. Facing Unexpected Health Conditions
If you or your family members are suddenly struck by a serious medical condition, it can cause a big hole in your pockets if you don’t have an emergency fund stashed away. Routine checkups, medical surgery, and medicines add up quickly. You might even need to use all your sick leave until eventually you are taking days off without pay.
If you have medical insurance, you may need to recheck with your insurance providers on your coverage as they may have limits on covering your medical expenses that can be expensive.
With well-funded emergency savings, you can better deal with these costs and make it bearable to get through those challenging times. Your treatment period should be a time for you to get enough rest and recuperate than to worry about upcoming financial situations as this will hinder a good recovery.
Reason #3. Paying Off High Interest Debts
You will not want to be in debt in the first place. And, it is somewhat controversial to use your emergency savings to pay off debt. However, it is good to have the option available to pay off high interest debts with part of your emergency savings.
With every financial bump in the road, your savings are there to help mitigate the situation as well as avoid you needing to add more to your debts. Those funds can help you to cover unexpected expenses caused by situations made by natural disasters or medical expenses.
By using your savings to handle these stressful events, it is easier for you to stay focused on resolving to get out of debts. Do make an effort to replace the money taken out from your emergency savings.
Tip: To ensure consistency for your emergency savings, include a monthly contribution in your budget until it is fully funded to the right amount.
Reason #4. Achieving Financial Goals
When you are working towards a goal like changing your career or owning a home, your emergency savings is one of the best ways to ensure that you achieve your goals. The savings provide a safety net that allows you psychologically to focus on your key financial goals without worrying about your finances. This is especially true if you have always been employed and are now looking to become an entrepreneur.
For example, if you buy a house, you need to put some down payment and make advance capital payments (while still being able to withdrawal if you have a flexible housing loan). A bigger down payment or capital advance meant your are paying less in interest on your property netting you some savings.
Although your progress to rebuild the saving may slow a bit, it will leave more money for your savings and this is a great way to prevent you from moving backward with your emergency fund. You can think of your emergency fund as a backup plan for any unexpected expenses.
Reason #5. Preparing for Retirement
Everyone wants to have a blissful retirement without having to worry about day-to-day survival, right? While your retirement savings in the Employees Retirement Fund (EPF) or your pension (e.g. public servants) will help provide you income, your emergency fund plays an important role by protecting that income.
If you are heavily invested into the market and there’s a prolonged correction or recession, you may be forced to sell investments at a lost to cover your living expenses. A larger emergency savings buffer is highly recommended for such situations if you are retiring or near retiring.
If unexpected expenses pop up, it can affect your monthly income. When you are retired, your income is fixed and might be slightly lesser than your working years, and there is no way to make up the difference between the money you currently have and the money you need without any streams of income.
For individuals that have a family, an emergency fund can help you to fund gaps when your children or other family members might need help. Your newly graduated kids might face problems getting a job, especially during a bad economic situation and as retired parents, you can help them first while they are looking for a job.
Emergency savings is a good way self-discipline lesson while teaching yourself the value of money. The main takeaway is the fund will give you some breathing space in the event of an unexpected financial blow while helping to prevent you from going into debt.
If you feel it difficult to build your emergency fund, try starting with a small amount, for example, RM10 per month. Increase the amount gradually whenever you feel comfortable and ready. Set in mind that this fund is for your future usage and peace of mind.
What drives you to save money for rainy days?