The Secret of Financial Security: Creating an Emergency Fund
A financial reserve, also known as an emergency fund, is a savings account that we set aside for unexpected expenses. It's a key part of a sound financial plan and can give you the peace of mind that comes with financial preparedness. In this blog, we'll explore the importance of a financial emergency fund and provide tips on how to build one.
Emilio Gučec | Personal finance | 1. September 2023
The Importance of an Emergency Fund
Life is unpredictable and unexpected expenses can occur at any time. A financial reserve can help you weather financial storms such as a job loss, medical emergency, or unexpected home repairs. Without a reserve, you may be forced to rely on credit cards or other forms of debt to cover these emergencies. All of this can lead to a vicious cycle of debt that is difficult to break.
A financial reserve can also give you a sense of security and freedom. When you know you have money for emergencies, you can focus on your goals, such as saving for retirement or buying a house. With a financial buffer, you'll sleep more soundly, it will be easier to make big life decisions, and major home repairs won't be a reason for an expensive loan.
How Much Should You Save?
The amount you should set aside as an emergency fund will depend on your personal circumstances, such as your income, expenses and job security. However, a general rule of thumb is to set aside three to six months of living expenses for emergencies. This means that if you spend €1,500 in a typical month, you should set aside between €4,500 and €9,000 as an emergency fund.
If you have dependants, a loan for an apartment, pay rent, or are self-employed, you may need to think about a larger financial reserve. One way to increase it is by investing in ETFs, which can be a great way to build your financial reserve for a number of reasons.
First, ETFs provide investors with a diversified portfolio of securities, which can help spread risk and minimize the impact of each individual stock or bond. Diversification can help reduce volatility over the long term, making ETFs a safer investment option for those looking to build their reserves. After all, no one wants their money for unexpected events to suddenly lose 80% of its value.
Start building a financial reserve for a better future.
Secondly, ETFs offer low costs compared to other investment options such as mutual funds, making them more accessible for those looking to invest with less capital. In addition, ETFs can be easily traded on an exchange, allowing investors to buy and sell quickly and easily. That gives them flexibility, regardless of whether they seek to invest for short or long term. In the context of building up a financial reserve, this means that the portfolio can be quickly converted into cash in the event of an emergency. Investing in ETFs can be a great way to build a strong emergency fund over time.
How to Create an Emergency Fund
Building an emergency fund requires patience and discipline. It can take months or even years to save enough money to cover three to six months of living expenses. Here are some tips to help you build a financial reserve:
1. Start small
If you can't manage to set aside a large amount of money each month, start with a smaller goal, such as saving €100 or €200. Once you have reached this goal, set a new one.
2. Cut unnecessary costs
Review your monthly expenses and look for ways to reduce them. Cancel subscriptions you don't use, eat out less often, and reduce your energy consumption to lower your utility bills. The money you save can go towards building your emergency fund.
3. Start investing
Investing even small amounts of money regularly over a long period of time can lead to significant returns. This is due to the power of compound interest, which means that you earn returns not only on the initial deposited amount, but also on accumulated profit. Over time, the returns can start to snowball and significantly increase the pace in which your investment is growing.
4. Automate your savings
Set up monthly standing orders from your checking account to your savings or investment account, ideally for the day after receiving your paycheck. That way, you won't forget to save and you're less likely to spend money on unnecessary expenses.
5. Avoid high-risk investments
People should avoid risky investments if they are saving for an emergency fund. High-risk investments have the potential for high returns, but they also come with a high degree of volatility and uncertainty, which can lead to significant losses. Examples of high-risk investments include, but are not limited to, individual stocks (stock picks), options, and cryptocurrencies. You should, therefore, focus on investing in low-risk instruments that tend to grow above the rate of inflation but do not experience such sharp fluctuations in value. An example is a mixed portfolio composed of stock indices and bonds. Such a portfolio can be created using ETFs.
6. Evaluate your financial buffer regularly
As your financial situation changes, it is important to regularly reassess your financial buffer. For example, if you get a raise or pay off debt, you can save more money each month. Conversely, if your expenses increase (e.g., because of starting a family), you may need to increase the target amount of your emergency fund.
Start investing today
A financial reserve is an important part of a sound financial plan. It can help you weather unexpected financial storms, prevent you from going into debt, and give you a sense of security and freedom. By following this advice, you can start building your financial reserve today and enjoy the peace of mind that comes with financial preparedness. Remember, the key to building your financial reserve is to start small, and here at Finax you can do just that. You have the opportunity to invest in 80% of the world's market economy for as little as €10. Over time, your financial reserve will grow and you'll be ready for whatever life throws at you.
