Some aspects of personal finance are exciting, such as investing in the stock market or buying a new home. And then there are the less thrilling things such as the long process of paying off debt.

Another personal finance task that can be daunting is building up an emergency fund, but it is a necessity no one can afford to ignore.

What an emergency fund is

An emergency fund is an account used to store funds for an emergency. This can be the loss of a job, a major illness or other unexpected, unavoidable expenditure.

The main purpose of keeping an emergency fund is to stabilise one’s financial security and eliminate the need to go for high-interest loans.

The purpose of an emergency fund

Everyone needs to be prepared for unexpected events. The best way is to have sufficient liquid money ready to use. The last thing anyone wants is to be compelled to take on loans or credit card debt.

The current economic turmoil has caused many layoffs, or if an individual wants to switch jobs or create a new source of income, this fund will be their best friend in the meantime.

Medical costs can skyrocket and having an emergency fund means one does not have to choose between health and rent. There are so many situations where some extra cash is needed. An emergency fund is a necessity that cannot be overemphasised.

How big an emergency fund should be

Generally speaking, it should be sufficient to cover living expenses for three to six months at least.

This is a general estimate and a more accurate answer to the question would be – every single person is in a different situation and the emergency fund requirements will vary.

1. Do you own a house?

If so, how old is the structure, the appliances? A homeowner would be wiser to plan for an emergency fund of six months. The more assets one owns, unexpected expenditure is more likely to pop up.

2. How old is your car?

The older a car gets, the more repairs it will need. Although individual repairs might be inexpensive, they can add up over time. If one’s car is very old, aim for six months of living.

3. Do you have a stable job?

This is probably the most influential factor that determines the size of one’s emergency fund. The self-employed, seasonal contact workers or freelancers should have six months of living expenses over the safe zone.

Those with stable jobs, or who work in high-demand industries with a good probability of securing a new job quickly in case of a sudden layoff, are good to go with three months’ expenses.

4. Are you well-insured?

Make sure the health insurance is good enough. The top reason for bankruptcy is a major medical crisis outside the coverage of health insurance. If one foresees medical expenses, have a six-month cushion.

Sometimes, insuring oneself is not enough. Family members who are dependents of the breadwinner are also exposed to health risks. If the whole family is adequately insured, it is okay to have a lower emergency fund buffer.

5. How big is the family?

The bigger the family, the greater the chances of unexpected expenses, so save for six months. For a single person with a steady job, three months’ living expenses in the bank is good enough.

These questions are not all that that should be considered when setting up an emergency fund. As stated earlier, the cases are different for different people.

The individual must evaluate their life, predict their future needs and choose a comfortable target.

Calculating the size of an emergency fund

The most common calculation is based on monthly expenditure. Everyone should have an idea of how much money is required to comfortably cover a month’s expenditure.

An emergency fund should be able to cover a minimum of three to six months’ expenditure, but a bigger cushion is always better.

What should be done with the emergency fund?

The emergency fund account should be separate from the regular bank account in order to avoid the temptation to use it for ordinary expenditure.

For an individual, a fixed income fund is an excellent option. These funds invest in the short term and are highly conservative.

The net asset values of these funds do not vary much. They invest in bonds issued by governments and large-scale companies, so they are perfect for investors who prefer not to put their principal at risk.

Starting an emergency fund

Set a reasonable target, like RM1,500. This goal can be reached in a few months (or even less depending on how much one can out aside). Despite being a small amount, it can make a huge difference in an emergency.

Now break this amount into smaller pieces. Putting away RM125 a week will add up to RM1,500 in just three months. So, the target should be challenging but not unreachable.

Many young people especially, who are just beginning to build an emergency fund, might think it would be difficult to save RM125 a week, considering they may be barely making ends meet now.

This problem can be overcome with a few tricks. Look out for ways to save small amounts here and there, put them away and see how fast the emergency fund grows.

This article first appeared in kclau.com

KC Lau’s first book Top Money Tips for Malaysians has sold thousands of copies. He launched the first online personal finance course specifically designed for Malaysians, entitled the Money Automation System. He also co-founded many other online financial courses including the Bursa Method, Property Method, Founder Method and REIT Method.