Should You Build an Emergency Fund and Why?

Indeed, let’s take a step back from all this unpleasant debt-talk we’ve had lately and delve into the unexpected emergencies of life with utterly morbid fascination. Because why not? After all, it’s the holiday season, and nothing rings ‘emergency’ more than the last-minute Holiday present run.

In all seriousness, the topic we’ll explore today is tightly-knit with your overall financial prudence. Just as much as managing your credit card balance is. On some occasions, it’s one and the same, even.

What is an emergency fund?

Nowadays, the pressures of life are ever mounting. To add even more, there are now 15-year-olds alive that have already experienced not one BUT two global recessions during their yet short lifespans. Such occurrences always resonate most in the lives of individuals. These global-scale maladies have manufactured many-a-personal financial emergencies. Especially for those who already seem to be most vulnerable.

It is safe to say that losing your primary/only source of income is one of the more challenging situations a person can find themselves in. Yet, it is also often one of the least expected situations. And people are sometimes completely unable to cope with it. Then there are the unfortunate cases of unexpected illnesses and health issues. Or even something as mundane as your trusted 2001 VW PASSAT breaking down on your way to work one frosty morning in late 2021.

In our rather expeditious everyday routines, these abnormal situations can indeed be deemed emergencies. And to deal with them promptly, you would require additional funds set aside for just such occasions. Hereby comes the term ‘emergency fund’.

The emergency fund that you build will turn your full-blown emergency into a mere inconvenience. If you have enough set aside, that is.

How (big) to make one?

As far as the ‘how’ part of this question goes – we already did a similar topic a few weeks back on How to Minimise Your Monthly Expenses. By reducing your expenses, the amount of your available finances should increase. Combine that with a possible side gig, if you find one that suits your skill level and schedule. And you will be well on your way to some much-needed extra money. How you should go about using these funds is entirely up to you. However, there are a few tips we already went over previously and will touch upon again this time, too. All in good time.

The ‘how big’ part is slightly more nuanced. Although it is possible to go on with an amount that you yourself feel comfortable with, most proponents of this financial tool would suggest anything starting from 3 months of pay’ to 8 months of pay’ worth of savings set aside for emergencies. For example, if your monthly income is €2,000, the emergency fund would preferably start from around €6,000 all the way up to €16,000.

Is there any way I could prepare for a financial emergency without putting this much money aside?

Well, yes.

Preparing for an emergency doesn’t have to put you in a hole almost at the same rate an actual emergency would. There are many ways you can safeguard your wellbeing without putting any cash up to dry.

For instance, in case you’re worried about being laid off during yet another wave of the current (or next) pandemic, understand that most European countries provide unemployment benefits for people who work officially and pay taxes. According to OECD data, these unemployment benefits vary in length and amount – depending upon where in Europe you work. But these benefits are there to protect you, at least for a short while.

Concerning sudden health issues and property damage – you can be prepared for these without having to save up thousands of euros, too. These days it’s possible to insure almost anything, but most insurance companies specialise exactly in two fields – health and property. Of course, you will have to pay monthly, quarterly or yearly premiums to use this type of protection. However, it would take years for the total of these premiums to amount anywhere close to your suggested minimum 3 month emergency fund.

You can also insure some of your debt. That’s called Loan Protection Insurance. It covers certain types of loans, usually up to a 24-month period. Typically, you can use this type of insurance to help yourself meet the minimum required monthly payments on personal loans, car leasing and credit cards.

All you need to do is a little research in order to find out about what benefits you’re entitled to as a taxpayer in the EU. And approximately the same amount of research to find the most suitable insurance for your needs.

So, should I or should I not build an emergency fund?

It depends, doesn’t it?

If you don’t have access to at least the basic unemployment benefits in your country for various reasons. If the available insurance premiums cost an arm and a leg as compared to what you can actually afford. Then by all means – build an emergency fund.

Putting your money aside for a rainier day isn’t good or bad. If you feel safer knowing that there is this solid chunk of change waiting for you to call upon it when in need – do what you must, to build the emergency fund.

However, if you’re not afraid to use your money in a more efficient way, you should also look into other options.

Let’s say, for example, that you have a sort of a typical financial situation – you have a decent wage. Yet, you mostly live wage to wage with some debt racked up. Would it really be financially prudent of you to save up to 8 months worth of salary and then just leave the money there, while it dwindles in value? Likely not.

In this type of situation, you would benefit more from putting that money to good use. An example would be using this extra saved amount to eliminate some or all of your acquired debt. Yes, we promised that this topic would differ for the sake of diversity, but paying off your debt, especially – high-interest debt, is one of the main pillars of your financial stronghold.

If you are in fact debt free, perhaps you would benefit more from using your extra wealth to generate even more wealth. Look into any source of additional income, be it active or passive. Starting a small business operation or investing your money can help your wealth grow exponentially. This way, you will secure your and your family’s well-being much more effectively than an 8-month emergency fund ever could.

In conclusion – don’t let your fear of a possible emergency somewhere down the road stop you from exploring different ways of generating more wealth with the wealth you already possess.

This blog entry should not be considered financial advice. For financial advice, contact a professional.