Editor’s note: This article was first published in March 2014 during the economic crisis in Spain. The remark that most people would struggle to save even three months of expenses “because of the crisis” reflects that moment.
As we have explained before, everyone, whether as an individual or as a family, should have an emergency fund to deal with life’s surprises and setbacks. But how much money should that fund hold?
Work out the expenses and financial needs you have each month: electricity, water, mortgage, food and so on. Your emergency fund should be able to cover those costs for 6 to 12 months if you received no income at all during that time, without having to sell any of your assets (liquid or illiquid).
Most people today will find it very hard to have an emergency fund that covers even 3 months, because of the crisis. But the truth is that a large share of the population never managed to build a fund covering at least 6 months, not even in the good times.
Not having an emergency fund, together with carrying too much debt, is among the biggest mistakes we make with our personal finances. These are the main reasons why you need an emergency fund:
1. The psychological factor when disaster strikes.
When we talked about how to deal with a personal financial crisis, we explained that everyone will go through one at some point in their life. The first step in facing it was to avoid panic and think calmly and intelligently. You will hardly avoid panic if, the moment you suffer a setback, your financial problems are on top of you within weeks because you live from paycheck to paycheck.
You have to avoid making desperate decisions, because they rarely turn out well. An emergency fund will give you that peace of mind and stability, as well as the patience you need to work out a strategy.
2. Losing your job.
All you need to lose your job is to have one. Some people see it coming, while others are caught by surprise. When our finances are going well is precisely when we should look for alternative sources of income and plan our emergency fund. Remember that sooner or later things always get worse, and the only way to avoid the impact is to prepare for it in advance.
(Read: How much we should save each month to be financially responsible)
3. Factors beyond our control.
The global or national economy can push our bills up. We may face astronomical price rises in basic goods, electricity, water and so on, and this may coincide with a pay cut at our company to avoid laying people off. Our income falls and the cost of living rises. That is when Murphy’s laws start to kick in, and our emergency fund can be the antidote that limits the damage.
4. Unexpected car and home repairs.
Your car can break down at any moment, and the repair can be expensive. In more extreme cases, you might have to replace it altogether. Likewise, at home you can face anything from a small breakdown (boiler, water heater, stove, plumbing problems…) to major disasters that your insurance does not cover. An emergency fund will keep you from having to borrow to pay for those repairs or disasters.
5. Illness.
If you are self-employed, an emergency fund should be a priority, because being ill will cost you money. In the same way, for pet lovers, vets are not cheap. And if we get a call saying that a relative on the other side of the country has died and we need to go to the funeral, the last thing we want to worry about at that moment is the cost of the trip.
In short, an emergency fund will not spare us certain problems or disasters that come out of nowhere, but it will help keep one problem from turning into another. Because money, whatever some people think, helps a great deal, in good times and in bad.
Further reading
Featured image: ScoredBlock, CC BY-SA 4.0, via Wikimedia Commons.
