Building up a Contingency Fund

*while I am away, recharging my batteries, please enjoy this guest post by Andreas from moneysupermarket.com; who writes about all things finance including savings, loans and credit cards. *

Financial experts advise that everyone should have a contingency fund in place for life's unforeseen events. But what is a contingency fund and how do you create one? A contingency fund is simply a pot of money that is normally kept separate from everyday finances and is used in emergency situations. Governments and businesses also have contingency funds.

Contingency funds are similar to savings, but are there to be used only in extreme circumstances. It is a good idea to have a separate account for your contingency fund and moneysupermarket.com details many providers.

The idea to separate your money is so that, whereas with savings you can dip in and out, contingency funds should be left untouched until an emergency arises.

According to statistics published by Bankrate's Financial Security Index Poll in 2010, twenty-four percent of Americans have no contingency fund at all and only twenty-two percent have limited funds. These limited funds would stretch to cover three months living expenses at the most, when financial experts suggest six months expenses are a minimum amount to have in a contingency fund.

This may sound like a huge amount of money, but the financial implications of an unexpected emergency can escalate quickly. The loss of wages due to redundancy or reduced hours can be the start of difficult times. Since the global economic recession of 2008 began, millions of Americans have lost their homes to foreclosure and many more have declared bankruptcy because of financial issues.

Besides unemployment and wage freezes, individuals every day become ill or suffer an injury or accident that prevents them from earning but creates additional expenses such as medical bills.

The slowing of the economy and the rise in food prices has meant that Americans have to do more, with less. For some individuals, this means borrowing heavily on credit cards just to pay day-to-day living expenses.

Those individuals who have a contingency fund can draw on this pot of money to help through these most difficult times. It can be a financial lifesaver and an emotional one too. The stress of money worries affects people in many physical and psychological ways. A contingency fund can provide a sense of reassurance and security that is invaluable.

It does take time to build a contingency fund, but the best time to start is right now. Even if you start with a small deposit into your fund, it is still a start. From small acorns great oak trees grow, so make a regular effort to contribute to your fund and find the best interest rate that will help it increase.

Aim for a month's living expenses and remember to include the small costs such as bus fares. It is a great idea to make changes to your spending so that you can deposit more money into the fund.  After you have saved a month's expenses, aim for three months and then six months. You will feel great satisfaction and a peace of mind that should the unexpected occur, you will be ready.

Mysti's Notes:  Many of you Dave Ramsey fans will recognize this as an Emergency Fund.  Emergencies WILL happen.  Be prepared!!  You may want to start even smaller than Andreas suggests...save $500.  Then work up to $1,000.  Then go for a month's worth of expenses!  Per Dave Ramsey, baby step 4 is a fully funded EF of 3-6 months of expenses.  You can't afford to NOT do this.  

And don't forget....there is a difference between a real emergency, and things that you should be planning for.  Car repairs WILL happen.  Christmas is December 25 every year.  Water bills, car taxes....these are all things you know are coming.  Don't dip into your EF for those...plan for them!!