Emergencies will always be a big part of life and there is no way to predict what and when it will strike which makes reserve funds all the more important. This fund is meant to act as a consumer’s financial safety net in case emergencies strike and hit their income. There are a lot of scenarios where having reserves can spell the difference between being able to pull through or drowning in debt.
One of the most common financial emergencies people face is when they lose their jobs. This was a common scenario during the most recent Great Recession. The housing bubble took its toll on the market and saw a lot of people losing their jobs. And finding a new one was an even bigger challenge because not a lot of companies were hiring.
Another instance where having reserve funds would totally come in handy is when a member of the family has to go through a medical emergency. Regardless if there is insurance or not, there will be a lot of out-of-pocket expenses that will come up. Not to mention the the family might also suffer some income losses because hospital stays and visits become top priority than reporting for work.
There are even emergencies at home where an unexpected home repair suddenly becomes a priority. It can be busted pipe under the sink and floods the whole kitchen and basement. It can be a few broken window glass that needs to be replaced before the rain starts coming in. Your car can also, without warning decide it needs new batteries or even a headlight replacement.
These instances and a lot more merit and actually underscores the importance of having reserve funds. This fund normally consists of two types of account – an emergency fund and a rainy-day fund. The former is meant to address the bigger needs while the latter covers for the small expenses that could eat up the emergency fund. Bankofamerica.com shares that the rule of thumb is to have about six month’s worth of funds in reserves but of course you need to factor in your family size and other financial obligations.
Why you need to have reserve funds
If you are still wondering why you need to sock away an amount for financial emergencies, here are a few more things you might want to know about the benefits of saving. Take a look and some of them might apply to your current situation.
- Insurance benefit. Insurance is an important component of life and a necessary one at that. The safety and peace of mind it provides consumers is quantified through a premium paid out to the insurance company. But there are deductibles that needs to be considered when talking about insurance. Investopedia.com explains that a deductible is the amount consumers pay out-of-pocket before the insurance kicks in. As important as it seems, the premium payment is still an expense consumers have to factor into their monthly budget so to be able to lower down the payment, they agree to higher deductibles. Having reserve funds allows you to do this because when you have a claim, you can use your emergency fund to cover for the out-of-pocket expenses. This gives you the chance to enjoy lower premium payments and have more on hand for savings or even investment.
- High interest rates. One of the sad realities when people find themselves into financial emergencies is that the most common sources of quick funds apart from having reserve funds are high interest sources. It can be a credit card cash advance, payday loan, pawnshops or even tax refund loans. Having a financial safety net prevents you from using high interest loans just to offset emergency needs. It helps you address the need and keeps you away from debt at the same time.
- Financial stress management. Have you found yourself on a long road trip and your fuel gauge is nearing empty with no gas station in sight but you are not worried because you have some spare gas in the trunk? Or how about going into an emergency meeting with a smile because you have everything you need prepared in your laptop? The same concept applies with your reserve funds because it helps you manage your stress as you deal with difficult times in your life. Money is an important factor and not having enough when you need to can complicate things. Having reserve funds allows you to deal with finding a solution rather than putting up the money to be able to solve your emergency situation.
- Continuity of way of life for your family. This is one of those things you might overlook when talking about the benefits of having extra money on the side for emergencies. It helps you continue making those payments on your house or car and other debts and not fall behind on your account. It helps the kids continue on with their daily lives and go to school and take piano lessons because you were able to factor it in your reserve funds. The money allows you and your family unimpeded way of life as you deal with financial emergencies.
How to build up reserve funds
Now that you have seen with the emergency stash can do for you and your family, here are a few ways to make sure that you are able to build up the fund. It usually takes time to get to a comfortable level but the sooner you get started, the faster you get to reach your goal.
- Know how much you need. The first step in putting reserve funds together is to know how much you need. To get to that amount, you need to compute for what your monthly expenses are. You need to factor everything in from the mortgage or rent to food all the way to small incidentals. The next step is to multiply this amount with anywhere from 6 to 12 months depending on your comfort level. Most people base it on how many months it would take for them to get a new job as it is one of the worst case scenarios that could challenge their emergency money.
- Commit to save a specific amount every month. As soon as you have an amount, you need to make a commitment to reach that level within a specified timeframe. You need to keep at it to make sure that you put the money together even before emergencies start to crop up.
- Save and forget. While you are in the process of building up your reserve funds all the way to completion, you need to remember to forget. What this means is that your emergency money should only be used for emergency situations. As such, you need to have clear guidelines on what constitutes an emergency in your household. This will help guide you in understanding when you can dip into your emergency fund or not.
- Update the amount as needed. As you go along, your financial situation can and will change. From having another baby to getting a higher paying job to even getting an extension on the house. These changes will definitely affect the amount of emergency money that you need to save up. It is not enough that you keep tabs on your savings but you also need to make sure that you are able to adjust the amount as you go along.
Having, growing and maintaining your reserve funds is an important aspect of your financial growth and maturity. As you move forward in life, you need to prepare for the unexpected and this fund will help you get through some of life’s unexpected challenges.