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How inflation can affect your emergency fund

POSTED ON MAY 12, 2023    

Financially-savvy people know that an emergency fund is a must. It’s so important that it should be the first thing you assemble, even before starting to invest. That’s because it can help you get past unexpected situations that require a large amount of money.


This is especially true if you’re about to start investing, since an emergency fund reduces the chances that you’ll need to withdraw money from your investments early and at a loss. This would lower their ability to make money for you, and make it much harder to achieve your money goal.


However, putting together your emergency fund isn’t the end. Read on to find out how inflation can affect your emergency fund, and what you can do about it.


Less buying power

Inflation causes the prices of goods and services to rise, so the purchasing power of money goes down. In effect, you won’t be able to afford the same things as before.


This would be a problem for your emergency fund, since it’s supposed to cover 3 to 6 months of essential expenses. If you calculated the amount in the past, it wouldn’t be enough for the same duration if prices rose because of inflation.


If you were counting on this fund to help you get through a tough time, like suddenly losing your job, you might find that you don’t actually have that much time to get back on your feet.


That can cause a lot of difficulty and stress, at a time when you’re probably experiencing a lot of both already.


Keep your emergency fund current

The way to avoid this unpleasant surprise is simple. Experts recommend that you review your emergency fund periodically to make sure that it has the amount that you need to protect yourself.


Aside from this, you should update your emergency fund ASAP once you’ve seen that there’s a significant change in the relevant economic conditions or your situation.


For example, if inflation is rising quickly, you should do the math to see if the amount you have in the fund is still enough. If it isn’t, you should try to add the extra money as soon as you can.


Otherwise, you’ll risk withdrawing from your investments prematurely to cover your sudden need for cash. This would be like not having an emergency fund at all, although the amount that you need probably won’t be as big.


However, an early withdrawal would still disrupt your investing strategy and make reaching your goal more difficult. That would still be something you should try hard to avoid.


The same applies when your personal situation changes, and your essential monthly expenses are higher than when you first made your emergency fund.

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