Emergency Fund; How to Build One and Why It’s Important
Last updated 24/08/2024
Did you know that close to 48% of Kenyan consumers face considerable financial stress? That’s according to Old Mutual’s financial services monitor 2024. While this doesn’t point specifically to emergency savings, it’s still an alarming statistic just how many of us are facing financial challenges. Unfortunately, it gets worse if an emergency occurs. You might think you’re covered, but when the time comes, will your savings really be there for you?
Sometime early in 2019, I had a family emergency that made me close my Sacco account and withdraw all my savings. While I treated this as my emergency fund throughout, it occurred to me last minute that it was not. The money was not easily accessible, and it was more of an investment than an emergency fund from the word go.
But that small event got me thinking; what would happen if I lost my job? How long would I survive in the city, paying my bills while looking for another job? So, I started saving small amounts of money where I could easily access the funds without eating into my long-term investments. It was not an easy journey, but less than a year later, the little money I had by then would come in handy when I lost my job.
Whatever your financial situation, setting aside money for emergencies isn’t just a smart move—it’s essential. If you are looking to build your emergency fund, you have come to the right place. Here’s everything you need to know about building an emergency, from how to estimate your target goals to where you can save.
An emergency fund is a form of savings account used as a safety net. Its main purpose is to protect you from the unexpected twists and turns life can throw your way.
This fund is not for everyday splurges or impulse buys. Instead, it’s reserved for situations that genuinely disrupt your financial stability. Think of scenarios like losing your job, facing sudden medical expenses, dealing with significant car repairs, or managing urgent home maintenance. These are the moments when an emergency fund proves its worth, allowing you to handle the crisis without derailing your long-term financial plans.
It’s important to differentiate between an emergency fund and other savings. While they all involve setting money aside, their purposes are distinct. Your emergency fund is for unexpected expenses only, while other savings might be for a vacation, a down payment on a house, or retirement.
To ensure your emergency fund serves its purpose, it’s important to have this fund in a savings account that’s easily accessible—liquid, in financial terms. This means keeping it in a place where you can quickly withdraw it when the need arises. The goal is to avoid scrambling to liquidate assets or dip into investments that were never intended for short-term use.
Back to my experience. My point is, that whatever you do, you need to set aside some money that you can count on during emergencies. That’s what we call building an emergency fund. Although it’s hard to scrape some cash off the little you already have, that fund makes you breathe easy knowing you’re covered. If this pandemic has taught me anything, it’s how important an emergency fund can be.
How To Determine Your Emergency Fund Target
The first step to building an emergency fund is to determine and set the minimum amount you need for emergencies. The rule of thumb is to have an emergency fund that covers three months of your living expenses. And by living expenses, I mean the basics, like housing, food, transport, and utilities. So, you figure out how much you spend monthly on these and multiply that number by three.
Does this sound overwhelming? It can be, especially if you are just starting your financial journey. But I have got your back! Here is a step-by-step guide on how to determine your emergency fund target.
Determine Your Monthly Expenses
Start by calculating your essential monthly expenses. This includes rent or mortgage payments, utilities, groceries, transportation, insurance, debt payments, and other necessary bills. Non-essential expenses, like dining out, vacations, and some subscriptions are not necessary for survival. As such, they should not be part of your emergency fund calculations.
Decide On The Coverage Period
Your next step is to decide how many months your emergency fund will cover. The rule of thumb is to have an emergency fund that covers three months of your living expenses.
However, I recommend aiming for a bigger emergency fund, at least 6 to 12 months. This will also depend on your personal preferences and risk tolerance. As you do this, consider factors such as job stability, family size, health, and any other ongoing financial commitments.
Related Read: Quick Start Emergency Fund: Step 1 to Financial Success
Calculate Your Target Amount
Now that you know how much you need to cover your monthly living expenses and how many months you want covered, it’s time to determine your emergency fund amount. You simply need to multiply your essential monthly expenses by the number of months you want to be covered.
For example, let’s assume you KShs. 30,000 per month to survive. This amount covers your rent, food, transport, and utilities. Let’s also assume you want to build a 3-month emergency fund. Your target amount would be KShs. 90,000. If you want to build a bigger buffer amount, a 6-month emergency fund, your amount would be KShs. 180,000.
Need help deciding how many months you want your emergency fund to cover?
Assess Your Starting Point
So, where do you start? For starters, review your current savings. How much do you have in your current bank accounts, mobile money, and other accounts? Then, identify how much of these funds can be earmarked for your emergency fund without affecting your other financial goals.
Next, consider your current financial obligations, i.e., personal debts, credit cards, mobile loans, and any other financial obligations. These obligations will affect your ability to contribute toward your emergency fund.
Additionally, you also need to consider your monthly cash flow. How much are you bringing in? How much goes into your expenses and debt obligations? Is the amount left enough to set aside funds to build your emergency fund?
Set a Savings Timeline
Your next step is to determine how soon you need to have a fully funded emergency fund. While it’s important to have it as soon as possible, it’s also important to set realistic a timeline. The last thing we want is to get you overwhelmed by the process.
Start by breaking down your total target amount into manageable monthly or weekly savings goals. Consider your current income, expenses, and any financial obligations to determine how much you can comfortably set aside each period. Aim for a timeline that balances urgency with achievability—something that pushes you to save but doesn’t strain your finances.
Adjust As Necessary
Keep in mind that life happens, and it’s okay if you need to adjust your timeline as you go. The key is to stay consistent, even if it means starting small. Don’t forget to regularly review your progress and make any necessary adjustments to keep yourself on track.
Tips To Help You Build Your Emergency Fund
When you are relying on your salary to cater to your bills, debt payments, investments, and other savings, it becomes quite challenging to have enough money for an emergency fund. There are four ways that you can free up more cash for your emergency fund.
Automate Your Savings
One of the easiest ways to build your emergency fund is by automating your savings. Set up an automatic transfer from your checking account to your emergency fund on the same day you receive your income. This way, you’re paying yourself first before any other expenses come into play.
Cut Unnecessary Expenses
Another easier way to fasten growing your emergency fund is cutting back on unnecessary expenses. Take a close look at your spending habits and identify areas where you can cut back.
Reducing discretionary expenses like dining out, subscription services, or impulse purchases can free up significant funds to put toward your emergency fund. Even small changes, like making coffee at home instead of buying it daily, can add up over time. Redirecting these savings into your emergency fund helps you reach your goal faster without drastically altering your lifestyle.
I recommend using a budgeting tool to help you identify your spending habits and where to cut back.
Get this Annual Budgeting Spreadsheet with a priority worksheet to help you determine how much you can save by cutting on specific expenses.
Take Advantage of Windfalls
Windfalls, such as work bonuses, or unexpected cash gifts, offer a great opportunity to boost your emergency fund. Instead of spending these funds on non-essential items, commit to saving a portion—or even all—of any windfalls you receive. This approach can give your emergency fund a significant boost and bring you closer to your savings target in a shorter amount of time.
Start a Side Hustle
If your current income isn’t enough to build your emergency fund at the pace you’d like, consider starting a side hustle. The extra money you earn can be directly funneled into your savings, helping you reach your target more quickly.
Where To Put Your Emergency Fund Money
While building an emergency fund requires you to put it in a highly accessible account, it does not mean letting it lay idly in a non-interest-earning account. Here are some of the best options for where to park your emergency fund:
Money Market Funds
Money Market Funds are a popular choice for emergency funds thanks to their liquidity and relatively higher interest rates compared to regular savings accounts. These funds invest in low-risk, short-term securities, providing you with a safe place to store your money while still earning a return.
The key advantage of Money Market Funds is that they offer easy access to your funds when needed, usually with the ability to withdraw within a few days. This makes them an ideal option if you want a balance between accessibility and earning potential.
Related Read: Is my money safe in a Money Market Fund?
Sacco Account
Are you a member of any Sacco (Savings and Credit Cooperative Organization)? While we talk a lot about saving/investing in a Sacco for long-term purposes—Member Deposits—it’s important to note that some Saccos also offer FOSA (Front Office Service Activity) accounts.
What sets this savings account apart from the Member Deposits account under BOSA is that the funds under FOSA are withdrawable without the need to leave the Sacco.
If your Sacco offers FOSA products, the savings account is an ideal place to park your emergency savings. Yes, these savings accounts earn interest, albeit at a lower rate than your Member Deposits account. However, you get access quick access to your funds during an emergency.
Related Read: Sacco vs Money Market Funds: Which is Better?
Term Deposits
There are two types of accounts to consider here:
- Fixed deposit accounts, and
- Call deposit accounts
A Fixed Deposit Account offers a higher interest rate compared to regular savings accounts but with one key limitation: your money is locked in for a specific period, ranging from a few months to several years.
This option is less liquid, meaning you can’t access your funds without incurring penalties until the term ends. However, if you have a portion of your emergency fund that you’re confident you won’t need immediately, placing it in a Fixed Deposit Account can be a good way to earn more interest while keeping your money safe.
A Call Deposit Account, on the other hand, is a hybrid between a savings account and a fixed deposit. It offers the flexibility of withdrawing your money with short notice—typically 24 to 48 hours—while still earning a higher interest rate than a standard savings account. This makes it a solid option for an emergency fund, as it combines accessibility with better returns.
One disadvantage of term deposit accounts is the high deposit amount required. Some will require as low as KShs 30,000 while other institutions will have as high as KShs 1M for the minimum deposit. Ensure you shop around, considering the minimum deposit required as well as the possible interest you will earn. Also consider the penalties for early withdrawal, especially if you decide to go with a fixed deposit account.
Treasury Bills
For those who are looking for a safe investment that also offers a bit more interest, Treasury Bills (T-Bills) can be a suitable option. T-Bills are government securities that you can purchase at a discount and redeem at face value upon maturity, typically ranging from 91 days to a year.
While T-Bills aren’t as liquid as a savings account or money market fund, they do offer a secure place for your money with a guaranteed return. This option is best if you’re willing to trade a bit of accessibility for a higher return and can plan your withdrawals.
Tip: I would recommend having some part of your emergency fund in a T-Bill. For instance, If your fully-funded emergency fund is KShs. 300,000, you can have half of this amount in a T-Bill. You get to lock money in a less liquid asset, reducing the chances of withdrawing for non-emergency expenses, and enjoy a higher return than you would in a Sacco or MMF.
Related Read: How to Invest in Kenya Government Securities
What Next?
As with anything else when it comes to your personal finances, building your emergency fund is not a one-time kind of deal. You don’t just set it and forget. Your emergency fund account requires regular assessment maintenance.
Regularly Review Your Fund Balance
Life is constantly changing, and so are your financial needs. Regularly review your emergency fund balance to ensure it’s still adequate to cover your current expenses. As your income, lifestyle, or financial obligations evolve, you may need to adjust your fund’s target amount.
For instance, if your monthly expenses increase or you take on new responsibilities, such as supporting a family member, you’ll want to increase your emergency fund accordingly. Make it a habit to assess your fund at least once a year or whenever you experience significant life changes.
Always Replenish After Withdrawals
If you’ve had to dip into your emergency fund, it’s important to replenish it as soon as possible. The purpose of this fund is to provide a financial safety net, so any time you use it, you should prioritize rebuilding it to its full target amount.
Set a plan in place to gradually restore the balance, whether by allocating a portion of your income each month or redirecting any windfalls toward your fund. The sooner you can get your emergency fund back to its target, the more secure you’ll feel in facing future unexpected expenses.
Protect Your Fund from Inflation
Inflation can erode the purchasing power of your emergency fund over time, making it less effective in covering your expenses when you need it most. To counteract this, consider periodically increasing your fund’s target amount to account for inflation.
Additionally, explore saving options that offer interest rates that outpace inflation, such as certain money market funds or Treasury Bills. Keeping an eye on inflation and adjusting your fund accordingly will help maintain its value over the long term.
Keep It Separate and Accessible
To maintain the integrity of your emergency fund, it’s crucial to keep it separate from your other savings and investments. This separation helps you resist the temptation to use the fund for non-emergencies.
However, while your fund should be distinct, it also needs to be easily accessible. Ensure that the account you choose allows for quick withdrawals without penalties, so you can access your funds immediately when an emergency arises.
Final Word
Building an emergency fund is one of the most important steps you can take to secure your financial future. It’s not just about setting aside money—it’s about creating a safety net that allows you to face life’s unexpected challenges with confidence and peace of mind. Whether it’s a sudden job loss, an unforeseen medical expense, or a major car repair, having an emergency fund means you’re prepared to handle these situations without derailing your long-term financial goals.
Remember, the journey to building your emergency fund doesn’t have to be overwhelming. Start where you are, and take it one step at a time. Every contribution, no matter how small, brings you closer to your goal. And don’t forget to regularly review and maintain your fund. This helps ensure it remains robust and ready to support you when you need it most.
Marlow marion
I had to grab my book and paper! Thank you
Enid Kathambi
Thank you. I hope you’ll start building your emergency fund now.