Make it a habit: Start the year with an emergency fund
An emergency fund is a requirement to financial independence. Everything starts here. If your family still doesn’t have an emergency fund, start saving for it this 2009. Or if your emergency fund is still not enough, beef it up for the new year.
But many people are still confused about emergency fund. How much should be your emergency fund? How long should it last? How do you compute for it? Why should we have an emergency fund?
There is no clear rule on how to set up your emergency fund. There is also no clear rule on how long should an emergency fund last. Financial planner and personal finance author Suze Orman recommends having an emergency fund of at least eight months. But because of the US economic crunch, Orman recommends having as much as 12 months of emergency fund.
Filipino personal finance author Francisco Colayco, meanwhile, recommends six months. It’s really up to you which one to follow. Personally, I follow Suze Orman’s eight-month rule.
What is an emergency fund for? Simply put, if you are not able to work, if you become unemployed, if you become sick, an emergency fund should be able to tide you over while you’re not earning money. An emergency fund should allow you to pay for your household bills and other payment obligations.
So how do you compute for your emergency fund? Basically, there are three approaches.
Option 1. Identify your fixed expenses monthly.
Identifying how much are your fixed monthly expenses will not take more than 10 minutes. List down all the bills you need to pay monthly. This should include household bills, grocery bills, insurance payments, loans, amortization, etc. If you’re paying some bill on an annual basis, just divide it by 12 (for 12 months).
Option 2. Use your gross income as benchmark.
This is a lot simpler. If you’re earning PhP30,000 gross monthly, just use this as your benchmark. Using your gross as a standard, this allows you to have more breathing room. However, if you’re earning a lot of money, let’s say PhP100,000, this means you should have at least 800K of emergency fund and this may take you a long time to achieve it.
Option 3. Use your net income as benchmark.
This is also simple as you only need to look at your payslip and see how much is your net income monthly. The tricky part is that many of us tend to spend more than our net income. Just notice how often we dip into our savings because we already run out of money two weeks after we received our salary.
When you have already chose which option to use as benchmark, just multiply it by how many months you think your emergency fund should last. So if you’re earning 30K gross monthly or have a fixed expense of 20K a month, just multiply it by six or eight months.