Emergency Fund: What it is & Why it Matters

Photo by Jp Valery / Unsplash

Financial emergencies are a reality of life. Whether in the form of an unexpected medical bill, a sudden loss of income, or even a broken appliance, they are unavoidable so it's only wise to prepare for them.

One common way to do this is to set aside funds that you use specifically for emergencies - an emergency fund. At the very least, it should help you avoid financial troubles when an accident or anything else happens.

In this guide, you’ll learn how to protect yourself using an emergency fund. We’re going to cover:

  • How emergency funds work
  • Why you need an emergency fund
  • How much do you need to have in your emergency fund
  • How to build it, step by step
  • Where to keep your emergency fund, and;
  • When you should use it

Let’s get started.

What is an emergency fund?

An emergency fund is a cash reserve that you set aside for use during urgent, unexpected, or critical financial situations. Examples of such situations may include surprise medical expenses, loss of a job, critical home repairs, etc.

It’s used for expenses that aren’t routine, which might crop up at any moment and destabilize your finances, sending you into debt or worse. So, it acts as a buffer by shielding you from falling into deeper financial issues if/when emergencies come up.

Why do you need an emergency fund?

Aside from keeping you prepared, here are a few more reasons why an emergency fund is important:

  • You won’t sink into debt - Because you’ll have ready funds on hand to help with your problem, you won’t need expensive loans that only serve to restrict your financial growth.
  • Your financial goals won’t be interrupted - If you have ongoing saving and investing goals, you won’t need to interfere with them to sort out your emergency. The savings or investments you’ve accumulated can keep growing smoothly.
  • You’ll eliminate needless worry - The security afforded by an emergency fund keeps you prepared for most interruptions, which reduces financial anxiety. As a result, you can pursue your goals with clarity and focus.

How much should you have in your emergency fund?

That depends on your circumstances. Things like your expenses, lifestyle, income, and debts play a big role in determining the size of your fund. To get started, however, target a sizable but achievable amount that can cover any short-term disruptions, say KES 10,000.

Once this is done, you can focus on building a fully-funded kitty, which most experts advise should be enough to cover at least 3-6 months of your expenses. This might seem like a lot but in a worst-case scenario (like a job loss), it’s going to keep you going while you sort things out.

The most ideal way to achieve this is by using a budgeting strategy. It’ll help you work your way up consistently by allocating a good sum toward the emergency fund each month.  Read on to see the specific steps you can take to set up your fund.

5 steps to building an emergency fund

How do you go from zero to a fully-funded emergency fund? Here’s how:

  1. Set a goal - what’s your target? Are you saving a small fund that’ll keep you safe for the time being or are you aiming for the fully-funded, 3-6 months fund? Whatever you want, have a clear number in mind before you begin setting the money aside. Clarity will help you organize your finances and track your progress.
  2. Create a system for consistency - now that you have your goal, how do you ensure you’re constantly moving towards it? By using a budgeting system. Budgets help to organize your finances such that your priorities are catered to before anything else. Adopting one will help you stay on course with your goal.
  3. Automate your savings - with your goal and budget set, it's time to actually execute the plan and put the money aside. To simplify this step, automate your savings so that you don’t have to do this repeatedly. This won’t just save you time, it’ll also make things considerably easier because it’ll eliminate the temptation to spend money on other things.
  4. Monitor and assess your progress - make time to check how well you're doing and see if you are on track to achieve your target. This step is especially important because it gives you gratification to see your goals getting closer. It also helps to reinforce the saving culture and can get you back on track if you had interrupted the process.
  5. Replenish once withdrawn - when the time comes and you withdraw your funds, make it a point to go back and refill it. There’s no telling when the next emergency is going to come up again so it’s prudent to remain sufficiently funded, which is why the system and automation steps of this process are important.

Suggested: The 50/30/20 Rule - How to create an effective budget

Where do you save your emergency fund in Kenya?

Again, that will depend on your preferences. However, a few factors should guide whatever option you settle on. These include the safety of your fund, its accessibility, and its liquidity. You want to be able to get your money fast and easily when an emergency strikes.

Here are a few places you can keep your emergency fund in Kenya:

  • Money market funds - they are ideal because of their safety and the higher interest rates that they offer. They are also very accessible because most of them allow for instant withdrawals, meaning you can access your money easily.
  • High-yield savings accounts - these are accounts that offer higher interest rates than typical savings accounts. The only catch is that the high-interest rates might be tied to a time limit, meaning you lose out if you withdraw the money sooner. Other than that, they provide both safety and accessibility.
  • SACCOs or bank savings account - another option is to save cash in a normal bank or SACCO account. The advantage of this option is the safety of your funds. There is no risk involved, and you can always access your funds when the need arises.

It’s important to keep your emergency fund separate from your normal accounts. This will ensure that you use the money strictly for qualified emergencies and not for other things.

When should you use your emergency fund?

Only when you're faced with ‘qualified’ emergencies. If it doesn’t fit as a ‘need’ and isn’t urgent or unavoidable, then it’s not an emergency and you shouldn’t dip into your funds for it.

Examples of emergencies include:

  • Unexpected medical bills
  • Job loss/loss of an income source
  • Urgent and critical repairs (like roof leaks or broken appliances)

You might want to develop guidelines about what qualifies as an emergency and what doesn’t. That way, you’ll be clear about when to use the money.

Don’t be afraid to use the fund when the need arises. Remember, though, that it’s essential to replenish it soon. Keep it filled and you’ll be ready for whatever comes up later.

Over to you…

As you can see, emergency funds are an essential part of a good financial plan.

They keep you prepared, therefore eliminating the fear and anxiety that come with uncertainty. They also keep you out of debt, which reinforces your finances. Building one is as simple as creating a budget, cultivating a saving habit, and staying consistent with your set goals.

What are your thoughts? Can an emergency fund impact your financial well-being?