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Digging Deeper in Building an Emergency Fund

An emergency fund is one of the foundations in building our wealth because it protects us from unexpected expenses that can dent our finances.

As a rule of thumb, an emergency fund is three to six months’ worth of our living expenses or salary, depending on your preference. I prefer to compute using my net pay, so it will relatively be larger. However, while building our emergency fund is simple, it is not necessarily easy.

For example, it took me three years to fill my emergency fund, only to be used up in less than six months after I resigned. Then it took me another two years to replenish it. But I don’t think of it as wasted since it served its purpose.

There are also many considerations when building an emergency fund besides the salary; it includes family obligations, debts, cost of living expenses, and others.

What if your salary is still small?

If your salary is still small and just enough for you to provide for your family and survive, you need a drastic change.

With a small salary, living within your means and even extreme frugality may not be enough to save for an emergency fund. The solution for this is to find another source of income like a side hustle or a second job.

With the Internet’s help, there are many opportunities available within the click of a mouse unavailable to the prior generations, so we need to capitalize on that.

However, if your current low-paying job requires you to work overtime every time, it will be challenging to find a side hustle.

If that’s the case, then finding another job would be in place. Just make sure to have a job-ready before submitting your resignation letter.

If you have consumer debts…

If you currently have consumer debts (not including your mortgage) and the interest rates of those debts are high, it will be advisable to pay them off first.

There are different strategies in paying off your debt, like the Debt Snowball and Debt Avalanche method. You need to identify which is more beneficial and practical for your current financial situation.

It is also important to communicate this to your family or spouse to be on the same page. The solution of getting out of debt will require teamwork from everyone involved.

While paying off your debt, it is still crucial to have an emergency fund since you’ll never know when you will need it. This is where a starter emergency fund comes in.

Begin with a starter emergency fund.

A starter emergency fund serves the same purpose as a fully-funded emergency fund. The difference is that this will be most applicable for those paying for their consumer debt.

The principle of a starter emergency fund is based on the Baby Step 1 in what Dave Ramsey teaches in his “7 Baby Steps” Program, which states that you should have at least $1,000 as a start.

However, it is not directly applicable in the Philippine context since $1,000 would roughly convert to PHP50,000, a value that can almost be 3x the monthly expenses of minimum wage earners.

Since the starter emergency fund will still be helpful, I suggest having at least P10,000 of the starter emergency fund saved. That amount is almost similar to the price of a mid-range smartphone.

Remember that this is only the starting point of your emergency fund. Once you pay off all of your loans, you need to reallocate the money you used to pay your debt to your emergency fund.

Don’t invest while you’re emergency fund is still not yet fully funded.

One of the common mistakes of people saving up their emergency fund is investing too soon.

It is common advice that you should invest as soon as you can. However, this is a bit dangerous without an emergency fund.

Since an emergency fund is a buffer and should only be used for emergencies, having none would force you to liquidate your investments if you needed money.

The problem will be in the liquidation process. If you’re invested in stocks without an emergency fund, you may be forced to sell some of your shares. This will incur an opportunity cost and even force you to realize your losses (if any).

Fully funding your emergency fund.

Since you already have a starter emergency fund, finished paying off your debt, and avoided investing immediately, then it is time for you to fund your emergency fund fully.

Try to save as much as you can and allocate it to your emergency fund. Do it month after month, and it will eventually be easier.

Just don’t fall into the trap of identifying a mall sale or an airline ticket sale as an emergency. Your goal will be to save at least 3 to 6 months of your living expenses or salary.

Once you completed your emergency fund, it is time to invest.

Fully funding your emergency fund may take some time.

Building your emergency fund will probably take some time, especially if you’re still not disciplined in the habit of saving. But don’t worry, it gets easier as time goes by.

Like in my case, three years is a bit long for saving for six months of my living expenses, but that was only a result of my undisciplined self regarding saving.

So when I used up my emergency fund the first time, I already know what went wrong. The second time I built my emergency fund, it only took me two years to save.

Remember that saving and investing are not for the short run. It is for the long haul.

Final Thought

Building our emergency fund is one of the foundations in building our wealth, but if you’re following IMG’s hierarchy, then you should already have a health and life insurance policy.

Saving for an emergency fund will surely take some time, but it will be worth it. You will also thank your past self that you developed the discipline to save for an unforeseen emergency.

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