It’s an emergency!
Title caught your eye? Picture these.
- Apple launches the newest iPhone and you just must have it. How will fund your purchase?
- Your company doesn’t do too well, and to stay afloat, the management decides to let go off some employees. You’re one of them. How will you meet your expenses until you find a new job?
- You’re having a good time baking a cake for a bake sale. Your oven malfunctions and there’s a fire. How do you deal with the repairs?
- The paint on your walls is wearing off, and you want to get a paint job done. How will you fund this?
The thing these statements have in common is that all of these require money. BUT there is a difference – some of these are planned expenses that you can save for over time (the iPhone and paint job), and some aren’t. Nonetheless, you need to be prepared for these.
This is where an emergency fund comes in. An emergency fund is money that you’ve set aside to cover any financial surprises life throws your way.
What is an emergency?
An emergency is “a serious, unexpected, and often dangerous situation requiring immediate action.” For example: job loss, a medical or dental emergency, unexpected repairs, unplanned travel.
How much should you save for emergencies?
The rule of thumb is to ideally have three-six months of expenses saved in an emergency fund. You can arrive at this by adding up your monthly expenses and multiplying it by the number of months. While you include regular bills on food, rent, electricity, water, fuel and other expenses, don’t forget to include loan payments (in case you have one or are considering one) and payments you make once a year like insurance.
Where can you put your emergency savings?
NOT your savings account. Why? While your savings are easily accessible, earn an interest and have no risk, it’s not a good idea to use this for emergencies. This is because you might give into the temptation to spend just a little extra every now and then, and this could eat into those funds.
Now, you would want your emergency fund to be an alternate to your savings account – one without a debit/credit card that’ll allow you to spend. Liquid funds are one such alternate. They’re easily accessible, can earn higher than savings returns, and come with low risk. Some liquid funds even come with an instant redemption facility. You may consider ultra-short term funds if your holding period is 3-6 months.
How to build your emergency fund?
- Regularly invest– Set up an auto-debit from your salary account to this fund. This way, when money comes in, a part of it is invested for emergencies.
- Review your expenses to see what you can do without– There’s a fine line between needs and wants, and even when it comes to wants, you don’t have to give up everything. One cab ride less, or fewer cigarettes a day and you might have money left at the end of the month.
- Use spare cash– Reviewing your expenses to see what you can do without can result in having cash to spare. Transfer this to your fund, so it’s untouchable until an emergency.
Benefits of an emergency fund
- Keeps you from spending unnecessarily– If you keep your emergency money in the same account as your savings, you may be tempted to splurge a little on frivolous things. Keeping it out of immediate reach keeps you from spending it.
- Decreased dependency on borrowing– An emergency fund keeps you from swiping your credit card unnecessarily, or from even borrowing from the bank to meet emergencies. This way you won’t have to worry on paying interest, fees or a penalty on debt.
- Lower levels of stress– Building an emergency fund prepares you to meet any financial emergencies, and this way you’ve lower levels of stress than if you’ve to deal with borrowing and interest payments.
Things to remember:
- Make sure you differentiate between planned expenses and emergencies
- Your emergency fund should fit in with your other goals
- Don’t forget to review your emergency fund from time to time, so you can add adequately to it with changes in your lifestyle and keep up with inflation.
If you haven’t got an emergency fund already, start investing for it today.