So you’re cruising along at work having yourself a great day when out of the blue something happens that completely wreaks havoc on your next pay cheque, your upcoming bonus, your access bond…..we all had this happen to us at some stage – the fridge stops working, the washing machine packs up, the car breaks down and the only thing that will breathe life into it is a major engine overhaul……and there is no EMERGENCY Fund to turn to.
Liberty Advisory Services discusses the benefits as well as the Do’s and Don’ts of an Emergency Fund.
The rule of thumb for an emergency fund is that you should have at least three months’ of living expenses saved. This creates an important financial buffer against major financial shocks such as retrenchment. While a major financial shock like losing your job can be a catastrophe it is often smaller, more frequent events that land us in financial difficulty.
If this month you had a medical emergency and your bills were not covered in full by your medical scheme, would you have the cash to pay? If you are in a car accident, do you have enough savings to cover the excess?
The reality is that most people view their credit cards as their emergency fund so whilst on one hand they are paying off their debts, if anything happens they are forced to take on more debt. It is this fear of having to fund an emergency that makes people afraid of cutting their credit ties. Most people who are over indebted will tell you that an unexpected financial event tipped them over the edge. Even if you are focused on paying off your debts, you should at the same time be building up an emergency fund so that you do not go back into debt.
If you have no emergency savings, it will take a long time to build up three to six months’ of living expenses – so start small. Dave Ramsey, author of The Total Money Makeover, recommends starting with just R1000 and then focusing on building that to R10 000 before you start to increase debt repayments. Once you have paid off your short-term debts then you need to focus on building up that emergency fund over time. Any additional money, especially a windfall such as a bonus or tax rebate should first go to topping up that fund.
THE EMERGENCY ACCOUNT
The aim of an emergency fund is to create a financial buffer, not to grow to fund your retirement; therefore you would have a very different investment strategy than you would for longer term savings.
Your emergency fund needs to be in a separate account so that you are not tempted to spend it on lifestyle “emergencies” like a holiday or a new outfit for a party.
While you do not want the funds to be too readily available they do need to be accessible within a day’s notice so putting it into a long-term fixed deposit also does not make sense. If you are still building up your emergency fund you will be limited to accounts with low minimum balances such as a savings account with your bank. Make sure there are no monthly fees on the savings account as this will eat away at your emergency nest egg.
Once you have built up a sizeable amount, around R20 000, you could consider a money market unit trust that pays a better interest rate than your savings account. Your funds are still easily accessible and paid out within 24 hours.
YOUR ACCESS BOND
Some people may consider keeping their emergency funds in their access bond. While this makes sense financially, as you are not paying interest on your bond for that amount, it does blur the lines if you are also trying to pay off your mortgage over a shorter time period. How much of the capital is part of your repayment plan and how much for emergencies? If you do decide to save into your mortgage ensure that the funds are accessible, not all mortgages are access bonds. Also keep in mind that if you do lose your job the bank is allowed to change your loan conditions and could retain the funds in your access bond.
Source: Liberty Advisory Services