An emergency fund is a designated amount of money that is set aside to cover unforeseen circumstances or financial emergencies. Often known as a ‘rainy day fund’, it serves as a financial safety net for unexpected events or situations that may disrupt your normal income or require immediate funding.
Emergency funds can be used for accidents and emergencies to cover expenses for medical treatments or vehicle repairs. They also come in handy should unexpected events happen, such as being laid off.
Characteristics of having an emergency fund
So, how do you define an emergency fund? Three key characteristics of such a type of fund that sets it apart from your regular savings or investments are:
Liquidity and accessibility
Emergency funds must be held in liquid form and be easily accessible. Whether that is in cash or in a savings account, these funds should be quickly and easily obtained when needed.
The ideal size of an emergency fund will vary depending on your regular needs and financial obligations, and what constitutes an emergency for you. Financial experts generally recommend having three to six months’ worth of living expenses covered in your fund. However, how closely you follow this guideline is up to you.
An emergency fund should only be used for genuine emergencies. These can include medical expenses, job loss, major car repairs, home repairs, and other urgent and unexpected needs. It is not intended for discretionary spending or non-essential purchases.
How to build an emergency fund
Emergency funds are personal, and they should be treated as such when planning for one. To build an emergency fund, you can consider the following steps:
- Set a savings goal
The first thing to do is to set a savings goal. Consider what you are saving towards, how much money you would need to be comfortable with your emergency fund, and how much you would like to cover with the fund. This means calculating six months’ worth of your expenses, including rent/mortgage, utilities, groceries, insurance, transportation, and debt payments per month, and multiplying it by 6.
- Create a budget
Then, you should have enough information to create your budget. Review your monthly income and expenses, identify where you can cut back and save more. Create a monthly budget that prioritises saving for your emergency fund. You can also look for opportunities to reduce spending by reallocating your non-essential expenses towards savings.
- Automate your savings
The key to an emergency fund – and good wealth management in general – is to contribute consistently. You can start small and make small contributions first. Treat it as a monthly commitment, so that you can make sure your fund grows steadily.
Common mistakes to avoid when setting up the fund
When setting up an emergency fund, it is essential to be aware of the mistakes you can make that can hinder your progress. Below are some common mistakes to avoid:
Not prioritising your savings
The first mistake is when you do not prioritise your savings. Even though emergency fund contributions do not have the same sense of urgency as bill or rent payments, it is crucial to treat it as a financial necessity.
You may also underestimate the amount of money you will need for your emergency fund. Remember to calculate your budget accurately and identify how much you will really need.
Not differentiating your fund from regular savings
Finally, mixing your emergency fund with other savings in your regular checking account can be confusing, and you may end up spending some of the money in the fund. Keep your emergency fund separate to ensure that it is preserved for genuine emergencies.
Other wealth management strategies
Aside from having an emergency fund, there is a lot you can do to make sure you achieve financial freedom and stability. Most of them involve working with a bank. An example is Saxo, a Danish investment bank that serves global clients and has a longstanding banking history in Scandinavia.
Savings accounts are a good way to preserve your wealth in a stable and low-risk manner. Savings accounts typically offer a low interest on your deposits, allowing you to keep your funds safe while receiving a small amount of returns over time. For those who wish to earn a bigger interest on their savings, they may also look at high-interest options.
Banks in Norway also provide retirement account options, either for personal use or sponsored by employers, such as occupational pensions. These accounts offer plenty of tax advantages, and they can be a good way for you to save up for life after retirement.
When opening an account with a bank, you can also invest in stocks, bonds, mutual funds, and other investment vehicles to help you grow your wealth and protect yourself against inflation. Depending on the bank, you may have access to a dedicated investment advisor who can help you develop an appropriate strategy based on your risk tolerance and financial objectives.
Financial planning services
Finally, if you have wealth in assets, such as real estate, jewellery, or investments, you can also explore financial planning services. If you have wealth in cash, you may also benefit from financial planning services such as budgeting, investment advice, goal setting, and more.
Take control of your life today
One of the most important things about having an emergency fund is that it allows you to take control of your life. It gives you something to fall back on in case of accidents and emergencies, and it grants you greater peace of mind as you navigate life.