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Ways To Build An Emergency Fund On An Unsteady Income

By Due
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Having stable finances amidst the pandemic has become more crucial than ever. The rising costs of healthcare and rent are crippling, especially to low-income families. Worse, economic uncertainties persist as the threat of the Omicron variant emerges. Also, unexpected home and car damages may happen during this freezing season.

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Despite the improvement in the labor market, the employment rate has not bounced back yet. It is no surprise that more people are willing to accept lower wages to make ends meet. We are more concerned about today’s concerns due to a lack of resources. So, we do not have adequate means to set aside an amount for unforeseen expenses.

However, we may face serious problems in emergencies. Banks became more rigid with loan approval while other lenders charged higher fees. That is why regardless of our income levels, we must try to save or look for other side hustles. In this article, we will look at how to build an emergency fund on an unsteady income.

Emergency Fund: An Overview

An emergency fund pertains to the amount set aside to maintain financial security. In essence, this is the portion of your savings that you should only spend for emergencies. You can use it to cover your urgent needs in times of financial distress. It creates a safety net not to withdraw money from your primary savings account. It also prevents you from resorting to costly options like bank or payday loans and credit cards. Hence, your retirement fund will remain untouched.

More often than not, an emergency fund consists of liquid assets. These are cash and other assets that can be converted into cash quickly. It is because you need to have the means to cover urgent expenses. Your investments in financial markets and receivables from debtors are some examples. They give you an instant buffer to stay afloat even when your earnings are inconsistent.

When you build an emergency fund, do not save a considerable portion of your income right away. Only set aside the amount that will not hurt your financial growth since you have constant expenses. But, be sure that the extra money will be adequate during future mishaps. It includes unexpected hospitalizations, unannounced layoffs, and property damages. The crisis in 2020 served as a lesson for us to be wiser in spending, investing, and saving.

The ideal value varies with several factors, such as your income level, expenses, and borrowings. Many financial advisors agree that the adequate fund will suffice outlays for three to six months. That way, your home can weather a stormy economic downturn. It is more valuable during unexpected unemployment or when facing an overwhelming hospital bill or student loans. But, other experts suggest higher value to cushion the impact of emergencies. For instance, Suze Orman believes that it should cover expenses for eight to twelve months. She also highlighted the devastating impact of the pandemic crisis. For her, building an emergency fund is more valuable than investing in the financial market.

Emergency Funds During the Pandemic Crisis

In 2019, over 70 percent of Americans could sustain urgent expenses for at least three months. It proved their increased financial stability. The vast majority could handle crises without having to borrow or touch their retirement savings account. The remaining 20 percent could cover their expenses for only one to two months. Almost two-thirds of the population has emergency funds for three months in Canada. Also, 65 percent said they could spend $2,000 if needed in the following month. Those earning at least $40,000 had more chances to come up with that amount.

The impressive numbers moved in line with the enhanced financial literacy globally. Investments and insurance are some of their typical manifestations. The world has witnessed several crises that turned economies upside down. The Asian Financial Crisis, the Global Financial Crisis, and natural disasters served as reminders. Economist Emily Gallagher said that the ideal emergency funds should be $2,467. Indeed, most people learned that earning more was as important as saving. Even so, the pandemic showed that our financial efforts were no match to its lasting impact. The global economic resilience dropped amidst the recession and limited opportunities.

In the US alone, the statistics dropped as most Americans depleted their emergency savings. From 14 percent, a survey showed that 51 percent could only cover less than three months of expenses. Moreover, only 39 percent could come up with $1,000 in unexpected situations. Even more alarming was that a huge portion would resort to borrowing to raise it. Less than a fifth said they would reduce their spending on non-essential goods and services. It was pretty disappointing that a crisis could harm our financial security and literacy.

In 2021, 25 percent of the interviewed individuals admitted to not having emergency funds at all. Their reasons were the exhaustion of their funds due to fluctuations in 2020. Others said they did not have savings even before the crisis. Today, almost half of the population struggles to get $400 for emergency expenses. In another survey, 58 percent of those earning below $40,000 could not save for at least three months of expenses. Among those earning above $80,000, 39 percent had emergency funds for less than three months.

Despite this, people across different generations are still optimistic about their finances this year. Fifty-three percent of younger millennials believe that their financial situation will improve. Other age groups are also hopeful, as the older millennials with 47 percent, Gen X with 45 percent. Likewise, 46 percent of the younger Baby Boomers anticipate financial recovery. So as the global economy rebounds, more people expect they will get back on their feet.

Given all the tolls of the pandemic, it was proven that emergency funds are crucial to stability. Having an amount for at least three to six months will help you get through a crisis. But, the greatest challenge lies in those living paycheck-to-paycheck. The unemployed, underemployed, and those with unsteady income will have to sweat more. Fortunately, there are some tips to secure funds for emergencies regardless of income. We will discuss them in more detail in the succeeding sections.

Top Emergencies People Face

Emergency expenses come in many shapes and sizes. The problem is that we do not know when or whether or not it will take place. Now that we are still at the height of the pandemic, these expenses are harder to avert. They will cause more problems if we do not have enough money to cover them. Bank or payday loans and credit cards are our go-to options. But little do we know that their interest rate leads to higher costs. Here are the emergencies people face, making emergency funds vital for financial freedom.

Job Loss

The pandemic led to lockdowns that contracted operations and disrupted supply chains. With massive losses across industries, many businesses shut down and laid-off employees. These scenarios drove the drastic increase in the unemployment rate. It was evident in hard-hit companies, such as hotels, restaurants, logistics, beaches, and casinos.

The global unemployment rate rose from 5.4 percent in 2019 to 6.5 percent in 2020 or 220 million people. The unemployment rate ballooned from 3.6 percent to 13 percent in only two quarters in the US. In Canada, the rate was a bit lower at 9.5 percent. The cost of losing jobs amidst the pandemic was not limited to lost income. It extended to depletion emergency funds to cover their expenses and other urgent needs.

Fortunately, things are starting to get better despite the threat of the new variant. The unemployment rate is decreasing, showing improvement in the labor market.

Medical or Dental Emergency

Emergency funds play a crucial role in providing a safety net in times of sickness. Going to hospitals or dental clinics has been an inconvenience to many people. It has become more expensive due to other costs associated with it. For example, patients and companions had to wear PPEs as safety measures.

The overcapacity in the healthcare sector led to rising costs of medical products and services. But, the biggest toll was driven by hospitalizations due to COVID-19. The global mean cost per patient was €10,744. So, it was no surprise that many people have used up their savings since the pandemic started. It was more burdensome for those without or who had lower funds.

Unexpected Home Repairs

Unexpected home repairs are more common now. Heavy snowfalls can cause damage to our roof, walls, and driveways. Trees in our yard may fall and hit our houses. Fires may break out due to overuse of heating equipment or neglected fireplaces. It can cost us thousands of dollars for a single repair. Emergency funds provide us with a buffer for our primary savings without home insurance.

Car Troubles

The demand for cars rose dramatically as more people avoided taking public transportation. The rising costs of buying cars came with the sudden increase in repair costs. Emergency funds are more valuable today, especially if you do not have car insurance. Also, this cold season can cause serious damage to tires and engines. Even if we checked everything during Autumn, it is better to set aside money for possible repairs.

Unplanned Travel Expenses

After locking ourselves in our homes for almost two years, travel is the best way to release stress. Indeed, there is a pent-up demand for travel and leisure as restrictions start to ease. But, travel expenses are not as essential as the others on the list. That is why we should make a separate space for our budget here. We should have at least three layers of savings. These include our primary savings, then emergency savings, and savings for non-essential expenses. That way, our finances are secure.

Benefits of Having an Emergency Fund

The purpose of emergency funds is to have something to use in unforeseen situations. That way, you will not touch your primary savings and retirement funds. Here are the benefits of building an emergency fund.

Benefit #1

Emergency funds help you make prudent financial decisions. Sure, you earn a lot of money, but even the top-earners are susceptible to bankruptcy. You may have instant access to cash through borrowings that may bear a high interest rate.

For instance, payday loan approval only takes a day or two. But, you have to return the money on the next payday. Worse, it bears at least 15% interest rate and can go up as high as 600%. Another type of instant loan is personal installment loans. Note that these types of loans can be predatory, especially if you do not pay on time.

Beware of unregistered lenders to avoid fraud and harassment. In 2021, many borrowers experienced bullying from lenders. Some borrowers were on the brink of losing their jobs due to lenders calling their employers. In other news, someone ended up with loans of almost $6,000 due to over 20% interest rate.

These can show why emergency savings provide financial stability. You will not also need to touch your other sources of funds. You can continue reaching your dreams while ensuring adequacy and sustainability.

Benefit #2

It helps you choose the best fund allocation. Suppose you are saving money for your dream house and car. You may allocate your savings solely on properties for faster payment completion. You may also want to invest in stock or cryptocurrencies due to promising returns. But in case of emergencies, you have nothing to use to pay your expenses. Worse, you may even have to sell them to cover your unemployment or hospital bills.

Given this, it is wise to allocate your savings to different areas. Even online banking apps have features to save funds for every goal. These include houses, cars, education, business, and of course, emergency funds. As the famous adage goes, “Don’t put your eggs in one basket.” Otherwise, you may lose most of your hard-earned money during unforeseen circumstances.

Benefit #3

Having emergency funds increases self-discipline. Have you seen the latest deals on your favorite online shop? There may be new items with huge discounts. But think twice before tapping on the add to cart and check out buttons. Financial advisors say that you should wait for a while and reflect on your planned purchases. If you ever change your mind after such a time, you don’t want those products. That way, you avoid spending on a whim.

In the same way, emergency funds make you aware of your spending habits. It helps you identify which is necessary and which is not. It will also help you determine how much you need to spend and save. It is better to put your money away from your debit card. After all, the phrase out of reach, out of sight has always been true. Put your savings, investment, and emergency funds in separate accounts.

Benefit #4

Having adequate emergency funds keeps you and your loved ones protected. The COVID-19 pandemic crisis damaged the financial security of many people in the last two years. Different studies showed that it led to the exhaustion of emergency funds. It became an eye-opener for most of us. The overwhelming hospital bills and the sudden business shutdowns led to a recession. As such, these funds can give an extra layer of protection.

Imagine those who lost their jobs or were hospitalized and had to borrow money with high charges. Many people and businesses went bankrupt. Even so, bankruptcy filings dipped in 2020. Thanks to debt moratoriums, fiscal stimulus, and state re-openings. But those with emergency savings had more time protecting their finances. The statistics in the previous section are a testament to its importance.

Benefit #5

Adequate emergency funds keep your stress level low. Even in trying times, it prevents you from getting anxious. Our financial health can affect our physiological and mental health. The relationship between finances and well-being is more evident in retirees.

In a 2013 study, it was found that loans could affect our blood pressure. Data showed that those with loans had higher perceived stress and depression levels. These were higher than the mean values by 11.7% and 13.2%, respectively. Likewise, they had higher diastolic blood pressure, 1.3% higher than the mean. The combined findings could tell that they had a higher risk of hypertension and stroke. Other studies did the same and applied Cronbach Alpha to prove the significance of the data.

With that, it is safe to say that emergency funds prevent us from incurring higher costs. It will eliminate or reduce our need to borrow money or touch our retirement funds. Due to financial instability, physiological and mental health problems can lead to more costs. You do not have to suffer from these consequences with funds for emergencies.

The Difference Between Emergency and Savings Funds

In general, savings are the portion of our income that we aside for future needs or investments. It has different purposes, ranging from unforeseen expenses to financial goals. But, our common mistake is that we put all our savings in a single pool of funds. Maybe that was our idea of savings funds when we were young. Now, we have to understand that saving is similar to budgeting. It also has many areas where we should put our money for better management.

Meanwhile, emergency savings are savings that we only use for emergencies from the name itself. Some examples are joblessness, hospitalization, and home damages. Of course, there are savings funds for medical expenses. But think of your emergency savings as your source of instant funds when your medical savings are insufficient to cover the total hospital costs. These are money separate from our savings funds. That way, our savings for other aspects, such as business and retirement, will remain intact. To understand them better, these are some examples of savings funds.

Retirement Savings

Even if you have a pension fund, a 401(k) plan, and an IRA, saving for your future is wiser. Retirement savings will help you have higher funds when you are already in your sixties. You can use this for your other important needs that your retirement plan cannot meet. Many retirement savings accounts have advantages over taxes. For example, the value you can contribute can be as much as your income before taxes. But of course, it has a catch. You cannot withdraw the money until you retire, or you will pay penalties for early withdrawals.

College Savings

College savings accounts will serve as your children’s educational plans. The purpose of this plan is designed to save for tertiary education. For example, you can put in a 529 plan, which promises tax benefits. This fund is separate from time deposits if you have any. Just use it solely to cover education-related expenses. These include their tuition fees, student loans, and even lodging fees if they rent near the school.

Personal Savings

These include funds for whatever plans you have for your future, depending on your financial circumstances. It can be your dream car, dream house, or even your dream travel package.

Medical Savings

Health insurance is a benefit in many companies globally. But, it cannot always cover all your expenses. For example, some doctors do not accept payments via health insurance. It is common in the field of neurology. As such, you will have to shell out more money because their fees and procedures are costlier. You can cover your medical expenses that health insurance cannot with medical savings.

Cash Cushion

A cash cushion is money that prevents overdrawing and bouncing checks. It is more common in checking accounts and provides more protection against overdrafts. The typical cash cushion amount ranges from $100 to $1,000.

Rainy Day Savings

Emergency funds and rainy day funds are similar in how we use them for unexpected situations. But they differ in terms of the costs incurred. Unlike emergency funds, rainy day savings do not have to be large. It often covers smaller unexpected expenses like field trips and vet bills for your pets. It ranges from $100 to $1,000 on average.

Emergency Savings

Unlike the previous savings, emergency savings are used for big unexpected expenses. Some examples are hospitalizations due to COVID-19, accidents requiring surgeries, and massive unplanned house damages. The large amount of money you will have to spend and the circumstances separate it from medical and rainy day savings. It will serve as our lifebuoy during mishaps. Hence, it keeps our financial health solid and intact.

How to Build an Emergency Fund

Financial experts often talk about the 50-30-20 rule. Fifty percent of your income goes to your constant expenses, such as food, utilities, and housing. The other thirty percent goes to the goods and services you want to buy. These pertain to your luxuries, such as gadgets, relaxation, and even spending on online games. The remaining twenty percent will become your savings. But, other people advise us to save first and spend what remains, encouraging us to become more frugal.

But either way, it is challenging when our income is lower than our needs. It will never be easy-peasy to live within our means when our expenses are higher than we expect. How much more during this time when underemployment becomes more rampant? As such, here are the steps in building an emergency fund, especially on an unsteady income.

Step 1: Tally All Non-Discretionary Expenses

Non-discretionary expenses are mandatory or necessary expenses. In other words, these are expenses we incur regularly. We can limit them, but we cannot avoid them. Here are the typical examples of non-discretionary expenses you must tally.

  • Housing
  • Food
  • Utilities
  • Child care
  • Taxes
  • Education and student loans

Since we pay them every month, it is easy for us to keep track of our expenses. Housing or rent, taxes, and education and student loans are fixed in general. But, the other three can be adjustable. We have to check which among them incur more expenses. From there, we can find a way to limit our consumption and save more.

For example, you can limit your spending on food by buying groceries and cooking at home instead of dining out or having food delivered. You can also reduce your water consumption by doing simple hacks like putting a plastic bottle in your toilet tank or turning the faucet off while brushing your teeth. Often, we do not turn off or unplug appliances when not in use. We overlook these simple but helpful tips.

Step 2: Tally and Adjust Discretionary Expenses

In contrast, discretionary expenses are our expenses on non-essential items and services. These include your new clothes, phones, and hobbies like shopping and watching movies. Our Spotify and Netflix subscriptions are also part of it. Often, we exceed our target spending because of these. We tend to spend more on discretionary expenses as online shops increase. Yet, we forget that it is up to us to limit and even avoid spending on them.

For example, having a car means increasing your property. But are you going to pay it fully or resort to bank financing? Why buy a car if you can take a bus, cab, or train? In microeconomics, discretionary goods and services are price elastic. Meaning we can constantly adjust when there are price changes. So, when they become more expensive, or our income drops, we can remove them from our budget.

In recent years, spending on non-essential items was at least $18,000. If we compare it to the average income of $48,672, we can see that it comprised at least 37% of income. Given this information, it is always important to tally and adjust our discretionary expenditures. Doing so will help us maintain the security of a stable income. We will not have to turn to financial institutions for interest-bearing accounts during unexpected financial emergencies. Here are some tips for doing it, especially on an irregular income.

  • If you mainly use your debit card for purchases, comb through your bank account statements.
  • Comb through your credit card statements if you mainly charge purchases and pay them off in full by your statement due date.
  • If you mainly use cash, track or reverse-engineer your spending over months.

Step 3: Calculate Your Average Monthly Income

Keeping track of the average monthly income is an important step to identifying our consumption and savings. It’s as essential as monitoring your business expenses, and is a must for freelancers and business owners who are not working fixed hours or earning irregular income. That way, you can also calculate and set a target consumption and savings rate.

Keep in mind that unfortunate events may come when we least expect them. So, having an emergency fund, especially on an unsteady income, is crucial. It will prevent you from borrowing from lending and other financial institutions. Here are some pointers to guide you in calculating your average monthly income.

  • Trace back your income far enough to cover seasonal ups and downs. That will be twelve months.
  • Check the outliers or the months when your income was much higher or lower than the typical values.
  • Compare it to the months with similar income ranges to see if the variation is still predictable.
  • If the variation is too high, you can go back further. That way, you will determine if the highs and lows are due to seasonal or sudden fluctuations.
  • Once done, calculate the average monthly income, flexible enough to massive changes.

Step 4: Find Your Effective Savings Rate

This step is dependent on the third step. Once you determine your average monthly income, you can set an effective savings rate. An effective savings rate should be enough to plan for your goals and cover unexpected instances. But, it should not hurt your budget for non-discretionary expenses. It is more crucial for those earning unsteady incomes. If ever you receive a pay raise, you may increase your target savings rate. Here are some tips for calculating an effective savings rate.

  • Subtract your target savings from the average gross monthly income
  • Divide the difference by your average gross monthly income
  • If discretionary expenses include scheduled savings, add those back to your income before subtracting your expenses.

Step 5: Calculate Your Ideal Emergency Fund Size

Once you set an effective savings rate, it is time to calculate your ideal emergency fund size. You need to be dedicated to saving money to set aside an emergency fund. Your savings and emergency should be ideal, especially in times of income lows. For example, your average income is $4,000. During seasonal ups and downs, your income amounts to $7,000 and $2,000, respectively. From there, you can calculate your savings and ideal emergency fund size.

If you are a seasonal worker, be sure to save an emergency fund that can cover you once your work ends. It will help if you have many side hustles.

Step 6: Create Separate Accounts for Income and Short-Term Spending

We tend to change our spending habits when combining our income and short-term spending accounts. Regardless of our employment or business type, it is wise to have separate accounts for our income and consumption. It makes keeping track of our expenses easy and accurate. Chances are, we limit our spending, which can increase our savings. These are the things you can do for this step.

  • If you’re an independent contractor or sole proprietor with a legal business structure, open a business checking account to receive income.
  • If you’re not formally incorporated or not qualified to incorporate because you’re classified as a traditional employee, open a second personal checking account to receive income only.

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Our financial literacy increases as crises teach us to handle our finances better. The pandemic has shown us how our wealth can be depleted in the wink of an eye. The thing is, emergency funds have become more crucial than ever before. It provides another layer of financial protection in times of unexpected misfortunes. There are still many things to understand in spending, investing, and saving. But with emergency savings, you are sure to achieve your goals while ensuring your financial security.

Did the article help you with your concerns and questions? To read more articles, check out our page on DUE. Due specializes in guiding people towards prudent financial decisions for a secure future. If you wish to know more about retirement plans, pensions, and insurance, reach out to our experts.

Article by Chris Porteous, Due

About the Author

Chris Porteous is a growth marketer, helping freelancers and small businesses become financially independent. Previous to this, Chris worked at prestigious financial institutions including: Goldman Sachs, UBS Securities, Garrison Hill Capital Management and DBRS. He is a frequent contributor and has been featured in publications, including: Entrepreneur, Forbes, Inc, Zerohedge, Lifehack, and more. Fun fact, his previous company Our Paper Life (that was acquired), built the largest cardboard beach in the world.