Need money for a rainy day? Create your emergency fund
When we explain the fundamentals of personal finance, one of the first concepts we refer to is that one of an emergency fund. Emergency – doesn’t that sound a bit dramatic? It might – but the very moment that you receive an invoice for an unforeseen car repair or need to travel home because your aging father is in the hospital, you’ll be grateful for it.
An emergency fund is a certain sum of capital that you save up and then stash away. Note that an emergency fund should be liquid (so not capital bound in any longer-term investment instruments such as bonds). Ideally, you place this money in a savings account or in a call money account (instant access account).
Money experts recommend allocating at least 2-3 months of your net income to your emergency fund. I have read articles that refer to 3-6 months (for example, The Balance author Miriam Caldwell does), but this depends on your job and how volatile the job market in your industry is.
If the idea of saving up 2-3 months of your net income seems daunting to you, break down this savings goal into smaller steps. For example, you can decide to dedicate 12 months to saving for your emergency account, by either saving the same amount each month, or gradually increasing your saving sum per month.
Practical tip: Let’s assume your net income amounts to EUR 2.300 per month. Your emergency fund should thus contain 3 x EUR 2.300 = EUR 6.900. If you decide to save up the money for your fund within 12 calendar months, and save the same amount each month, you’d have to stash away EUR 575 per month. If you already know that you’ll receive a bonus payment of EUR 1.000 in March, you might add this into your calculations (EUR 6.900 – one-time contribution of EUR 1.000 – leaves EUR 5.900 to save in 12 months). Find a method that works for you, but make sure you save the cash for this particular fund.
If you are in debt, then we advise that you pay down your debt as soon as possible and then build up the emergency fund. How come we do not recommend that you do both simultaneously? You lose money when you owe a loan – the interest charged on the loan costs you in addition to the principal you owe. Pay down your loan aggressively, then start saving up for your emergency fund.
While we at Finelles recommend investing and making your money work for you in times of low interest rates for savings accounts, we are also very pragmatic. You need an emergency fund – full stop. One of the added benefits of having one: You will sleep better, because you will not have to worry about unforeseen financial emergencies.
Written by Caroline-Lucie Ulbrich
Finelles Founder. Coach and organizational consultant (ECB, Deutsche Bank and UBS).