How to set up an Emergency Fund

What is Emergency Fund?

Emergency fund(EF) is that portion of money one keeps in case of emergencies like health problems, losing job, accidents, death, natural calamities etc. It is a security on which one can fall on whenever there is a crisis for money. It is different from a savings account, because one need not touch this money unless it is really urgent. Experts say that ideally an EF needs to have a minimum of 3 months salary worth of basic living expenses.

Why EF is important?
It is important, because there are high chances of unexpected need for cash might occur. Also in case of emergency relying on a credit card debt, is not a wise thing to do because it will take years to pay up in the long run. An EF is necessary because when large bills incurs, one does not have to run from pillar to post in search for money.

How much is needed for EF?
As per experts, the minimum amount in your emergency fund should be three to six months worth of basic living expenses. Again the amount of EF is on a personal basis. It completely depends on the number of persons earning, whether single or couple, whether a person is supporting anyone else. Ideally, a single person can have minimum of 3 months of basic expenses and for couples or anyone with dependents it should definitely be an amount of 6 months worth.

FIVE steps to set up Emergency Fund

1. Open a Separate Account for EF:
Opening a separate account just for the purpose of saving up for Emergency Funds. The whole purpose is the categorize your money according to your expenses and savings. The money that remains after paying all the bills, can be put into this account.

The account types can be savings account, checking accounts, money market accounts, certificates of deposit, money market funds, and short-term bonds. These are good options to keep your money because you can take them at short notice. These are the most liquid investments. Liquidity refers to how quickly an asset can be converted into cash. However, find an option that can give you good interest rates.

2. Put aside $1000 to start off:
According to Dave Ramsey, financial expert, this should be the first step towards setting up the EF. From here you can start accumulating your target of a fully funded emergency fund with 3-6 months of your personal expenses set aside in a savings or money market account.

3. Pay off all debts starting with the smaller ones:
The third step would be to pay off your debts. Start with listing your debts from small ones to larger ones. It helps to pay off smaller debts first, because its easy to pay that off without accumulating it to a huge amount. You don't need to concentrate on the interest rates or terms unless two debts have similar payoffs. In this case, list the higher interest rate debt first.

4. Plan your expenses based on needs and not wants:
To save money, you need to spend less so you will have more cash to squirrel away. Start by buying only what you need, not what you want. Food, clothing, shelter, utilities, and transportation are just some expenses that can be considered as needs. Make-up, an extra DVD player or car, gourmet coffee, and a night out every week are examples of wants. Prioritize your needs, and allow yourself a want only once in a while. For instance, if you buy gourmet coffee every day from the coffee shop on your way to work, cut it down to once a week or once in two weeks. Save the money you would have spent on coffee daily and put it in your emergency fund.

5. Set up a time-restricted goal of funding amount:
A goal like this is made more concrete when you set a deadline. Complete your emergency fund in a year, if possible.