The real value of having an emergency fund will only be fully appreciated during an emergency like the current pandemic. During the lockdown period imposed to stop the spread of the coronoavirus, both businesses and individuals are severally impacted. Many businesses cannot trade during this period or on a reduced level resulting in no income or less income, but the expenses still have to be paid. Certain employees were put on unpaid leave or had to settle for a reduction in their salaries, but their living costs still have to be covered. Massive job losses are already predicted. Certainly this is a period causing stress levels to skyrocket. The individuals and businesses who are probably less stressed are the ones who have an emergency fund in place.
The question you should ask
The question you should always ask yourself is: If I cannot earn income for a period, will I be able to survive financially for the next six months? If you can comfortably and confidently answer that question, you most likely already have an established fund to cover your expenses. If that question scares you, start building your emergency fund today. Considering the current economic environment worldwide and factoring in the impact the Covid-19 situation will have on businesses and individuals, losing your job or no longer being able to earn an income or earning a reduced income might be more of a reality than you can imagine. Having an emergency fund to fall back on will become your saving grace if something like that does happen to you.
The purpose of an emergency fund
The purpose of an emergency fund is to have money available to pay for emergencies and unforeseen expenses. Think of it as your personal disaster support fund. The money set aside should be used for real emergencies and only for big expenses. Things that qualify as emergencies would include: major car or house repairs that aren’t covered by your insurance, losing your job or not being able to do business and having to pay for your monthly expenses without receiving an income, major medical expenses, etc. Something like having to go to the dentist for a routine check-up, buying a new TV or going on holiday doesn’t qualify as an emergency. Those type of expenses should be budgeted for as expenses in your normal annual budget and short-term savings should be used to pay for that.
How much should you keep in an emergency fund?
The rule of thumb is that your emergency fund should cover at least six months of your monthly ‘cannot-live-without’ expenditure. That includes all your usual monthly expenses like your home loan, school fees, car instalments, policies, insurance, groceries, etc. Ensure that you also consider those once-off annual expenses like new school uniforms, health check-ups, car service costs, etc. If you have a lot of debt, aim to initially set aside three months of expenses in your emergency fund. Thereafter focus on repaying your debt and once you are debt free, continue building your emergency fund.
Where to keep emergency savings
It is important that the money in your emergency fund is easily accessible (liquid) and that it carries no or low risk. The best options would be a savings account, money market investment or a credit card / debit card that is specifically used as an investment vehicle for your emergency funds. Refrain from notice deposits or longer fixed-term investments where you cannot get access to your money within a few days. Also consider any penalties that might be charged if you withdraw your money before the maturity date of your investment. Don’t be tempted to invest your emergency funds in higher risk investments like equity or offshore funds. You could receive higher returns but you are at risk that your funds might be worth much less than what you originally invested, should you urgently need to withdraw those funds at a time when the markets are not doing well. If you do have to use your funds for a real emergency, it is important to top up afterwards for future use.
Where to start
Calculate how much your emergency fund should be – monthly ‘cannot-live-without’ expenses including debt instalments for 6 months (or at least 3 months). Compile a reasonable plan to get there and start building your emergency fund today. These are options to consider:
- A good option to start building an emergency fund is to allocate a savings portion towards your emergency fund in your monthly budget.
- Your monthly budget should make provision for unforeseen / ad-hoc expenses. In the months where nothing unforeseen has happened, transfer that money into your emergency fund.
- Review your budget for any ‘nice-to-have’ expenses that you can cut going forward. Allocate those savings to your emergency fund.
- With the interest rate cut, you will have a saving on your debt instalments. Use those savings to build your emergency fund. Once you have a reasonable emergency fund built up, use those savings to repay your debt quicker. Having limited or no debt during periods where you cannot earn an income, will reduce the pressure to a large extent.
It does require discipline to put money away for something you might hopefully not use or to resist the temptation of buying that new big screen TV that is on special by using your emergency funds. Having an emergency fund is a crucial step in building your financial wealth portfolio and becoming financially independent. Remember, an emergency fund will become your saving grace when a situation similar to the Covid-19 situation recurs.