Especially in these times, saving for an emergency fund, as well as a contingency fund, will give you extra peace of mind in the event of unforeseen events. Many of us live from day to day (and sometimes with an amount less than our monthly salary saved as a reserve), so it is essential to have an economic cushion so that our goals do not get lost along the way and thus avoid getting into debt.
But how much money should we contribute to an emergency fund and how is it different from a contingency fund? Let’s watch it together!
What is an emergency fund?
In simple terms, an emergency fund is a financial safety net that protects you against those unexpected events in life. Instead of relying on bank overdrafts or finding yourself in a position to borrow money to get out of a crisis, you can draw on this emergency fund without worrying about the domino effect it will have on the rest of your finances.
What counts as an emergency?
You should only use your emergency fund when something truly unexpected happens that you have to take care of urgently. Some examples are:
- if you unexpectedly lose your job and therefore your source of income;
- if you have to pay sudden medical expenses;
- if the economy goes into recession and you lose a considerable part of your income
- if, for whatever reason, you have to move to another city.
How is it different from a contingency fund?
A contingency or contingency fund is similar to an emergency fund, only the latter is created to pay for smaller unexpected expenses. These eventual expenses include getting by in situations such as the following:
- buy a new refrigerator because the one you have has broken;
- pay vet bills if your cat needs medical attention;
- repair your car
- buy you a new phone if the one you have is stolen.
While all of these expenses are necessary, they are not as costly or dramatic as those that would require tapping into your emergency fund.
When should I create an emergency or contingency fund?
By creating your emergency or contingency fund you also save yourself future worries. If a crisis situation occurs (whether big or small), you will have your economic stability more or less assured and it will not be another stress factor. So you can focus on the things that really require your attention.
To anticipate events and have that peace of mind that comes from knowing that you have money saved, it is best to set it aside whenever you can (or, at least, once a month to have constant liquidity).
The advantages of having both an emergency and contingency fund are numerous. We explain why:
- you will reduce your stress knowing that you have an economic safety net;
- you will develop a saving mentality, and also preparing for the future will prevent you from making hasty economic decisions in the present
- An emergency fund also keeps you from dipping into other savings accounts in a crisis, helping you keep your savings goals unchanged.
How much should I save per month?
Experts estimate that an emergency fund should cover three to six months of fixed monthly expenses (including rent and bills). While some choose to include their variable expenses (grocery shopping, nights out, and general entertainment) in their emergency fund budget, the most common is to focus on ensuring up to six months of fixed monthly expenses saved.
The amount will depend on your lifestyle.
Whether you decide to save three or six months of your fixed expenses will depend on your means and your lifestyle. People who live alone and those with more unstable sources of income (such as the self-employed) will live more securely having six months saved. This is because your financial safety net may be more fragile than that of households where there is another person to support you during a crisis, and where there is more than one source of income.
Contingency or eventuality fund: how much should I save?
A contingency or eventuality fund should include enough money to deal with those small emergencies in life, but this will depend on your particular circumstances. Although the estimates range between €500 and €2,500, it is best to take care of yourself and set aside at least €1,000. However, keep in mind that €1000 may be enough to buy a new appliance or pay an unexpected vet bill, but it may not cover both at the same time.
Try to estimate how much you need to have in your contingency fund
A good method to calculate how much money you should set aside for your contingency fund is to analyze your current situation and try to predict possible future expenses. This will give you a clearer idea to know if you should save €500 or more. Some of these predictable circumstances may be:
- the costs of a repair if your car often breaks down;
- vet bills if you have an elderly pet;
- bills from the dentist if you are in the middle of a treatment;
- Analyze the age of your most essential appliances, especially those that are no longer under warranty.
When you have a clear idea of possible expenses that may catch you by surprise in the future, you can better calculate how much money you should save in your contingency fund and be prepared.
Start saving for a contingency fund before saving for an emergency fund
Since it’s easier to save for a contingency fund, it’s best to focus on setting that money aside before moving into the emergency fund. Typically, you’ll tap into this fund more often than the emergency fund, as your fridge is more likely to break down or your pipes clog than to have a life-changing emergency. Therefore, it is best to have a cushion for small surprises that will also help you advance in your savings goals for the emergency.
How to create an emergency and contingency fund
Creating and maintaining an emergency and contingency fund may seem complicated, but if you follow these guidelines, it will be very easy. If you incorporate these funds into your monthly financial management, you will get used to saving without realizing it. We explain how to create them step by step:
Prepare a budget
The first step in saving for a fund is to develop a solid budget. With these tips, you can start saving for an emergency now:
- Track your expenses and income for 30 days and write them all down.
- Divide expenses into fixed and variable. Your fixed expenses are all those that you cannot influence (rent, debt payments, car insurance), while your variable expenses are more flexible (going to the supermarket, going out at night, going to the gym).
- Decide what percentage of your variable expenses you can use to contribute each month, first to a contingency fund and second to an emergency fund. For example, if you have an income of €3,000 per month and your fixed expenses are €2,000 per month, you are left with €1,000 of variable expenses. Starting from them, you can choose to save 25%, that is, €250 per month. At the end of the year, you will have saved €2,500, which will become your contingency fund and, in addition, the beginning of your emergency fund.
Use an emergency fund calculator
If you have trouble calculating how much you have to contribute each month, you may find it helpful to use an emergency fund calculator. You can find these calculators on the internet. They’ll help you figure out exactly how much you’ll have left over to add to your emergency fund after subtracting all your fixed expenses. It is best to look for an emergency fund calculator that allows you to input many variables, as this will give you a more realistic view of how much you can save for your emergency fund each month.
Save something, no matter how little
If saving six months of fixed expenses seems like an impossible mission, it’s important not to get discouraged. It is always better to save something than nothing. For example, if you manage to save €30 per week, that’s already €1,440 per year, which is still a considerable amount. An emergency may come tomorrow or ten years from now; if not, it would not be an emergency. If you save €30 a week for 10 years, you’ll have a whopping €14,400 to meet any financial crisis!
Automate your savings
When you have prepared your budget, it would not hurt to automate your savings. That is, create an automatic transfer from your main bank account to your savings account every month so you don’t even have to do it manually and you won’t be tempted to spend it.
Adjust your budget each month
In order not to get discouraged, it is important to have a flexible budget, since income and expenses can undergo unavoidable changes. We recommend that you verify each month if you can really afford to deposit the amounts you have planned in your emergency or contingency fund. Do not be discouraged, it may also happen that you are in a position to deposit a little more than expected!
Prepare an auxiliary budget
An emergency or contingency fund should only be used when truly necessary, just like auxiliary budgets. Basically, a backup budget is the budget you fall back on when a crisis hits and money starts to get tight. It covers all your fixed expenses and it may be enough to cover basic supermarket purchases, but nothing more.
That is, you will spend every penny during the month in the hope that your emergency fund (plus the extra money generated by your auxiliary budget) can cover the expenses of that immediate emergency.
Perhaps the most satisfying part of saving is rewarding yourself every time you reach a certain number. For example, let’s say your goal is to save €6,000 for your emergency fund. Every time you save €1000 you can reward yourself with a special dinner, going to the cinema or shopping. It is important that the process is not a tortoise and can give you satisfaction, since this way it will be easier for you to commit to your savings goals.
Where to keep your emergency and contingency funds
Your emergency and contingency funds should be in a place that is easy to access in case of a crisis. A digital bank with a debit card or a savings account are ideal, since you can easily withdraw money wherever you are. It is also important that you separate the emergency fund from the contingency fund and these from your daily account, since this way you will not be tempted to resort to them.
Quick ways to set aside money
Like almost all things that deserve an effort, starting is always the most difficult. But saving may be easier than you think. If you find it difficult to get going to achieve your savings goals, we bring you a few tips to get a little running:
- Deposit all tax refunds, company bonuses and cash gifts directly into your savings funds;
- set aside a little extra money and, incidentally, clean up your house, selling things you don’t need on the internet;
- consider getting a second job or putting in extra hours at work to give your savings a boost
- try going for a month without expenses or, if that seems too difficult, plan one day a week in which you spend nothing (except necessary fixed expenses, of course!).