Emergency funds - just how necessary are they?

Cathy Lammas, Business Development Manager, Glacier by Sanlam.

Let’s face it, an emergency fund is the least sexy part of an investment portfolio. Until one has the financial muscle of a really good share portfolio, with lots of fat built into it or a home loan with ready access to extra cash, one does need the financial support of an emergency fund.

So what exactly is this fund?

Ideally it's a source of money, readily and easily available, without having to liquidate your other financial investments at inappropriate times. Life's little mishaps never seem to happen at a convenient time, making it all the more critical to have a fund.

Why is it so important?

Countless studies have shown that people without emergency funds are more likely to fall into debt, simply because situations will force them to take the first loan available, potentially robbing them of the opportunity to shop around for a loan with great terms and conditions and favourable, competitive interest rates. Often this is the start of a downward spiral into the dreaded debt trap. A survey conducted by wonga.com showed that a whopping 45% of those surveyed had taken a loan for an unexpected expense. The findings of the 2012 Financial Literacy Study in SA, a report commissioned by the FSB, were just as discouraging, reporting that less than a third of South Africans have even three months’ salary saved for an emergency.

For women in particular the need for an emergency fund is great. Statistics show that there tends to be a “gender gap” in financial planning in SA, where women are less likely than men to have an emergency fund. Considering the high rate of divorce and the trend for women to take on primary care of children after a divorce, the lack of a financial safety net does not bode well.

What exactly constitutes an emergency?

Broadly speaking an emergency should be anything that threatens our survival, not something that is a threat to our desire for comfort or social acceptability. One could use a car to illustrate this point. For many working South Africans a reliable car is essential for getting to work to earn an income. Repairs to this vital transport could thus be seen as a necessity, but dipping into an emergency fund to upgrade the sound system ... Not !

When is enough, enough?

The size of the fund is a hotly debated topic, but essentially the choice is a personal one. Since one of the primary functions of an emergency fund is to cover expenses during a period of loss of income, it follows that an emergency fund should cover at least three to six months’ worth of expenses. However, there are other variables which may play a role and thus the decision should ideally be made with the help of a professional financial adviser. Some of the other variables to consider would include:

• Home ownership: Owning a home brings with it the risk of things breaking, particularly in an older home. However if the property is being rented, one would not need to budget for repairs as these are usually the responsibility of the home owner.
• Car ownership: Similar to a home, a lot more can go wrong with an older car. Importantly one needs to consider that the older the car, the less likely it is to still be under warranty/motor plan and thus one needs to budget accordingly. One should also remember that even the best motor plan does not cover consumables such as tyres.
• Insurance: The more comprehensive the insurance plan - both medical and general - the better. When planning your emergency fund, you need to be very clear what is covered by your insurance plans.
• Job Skills: The period of time you are likely to be unemployed in the event of you losing your job, has a great influence on the size of your emergency fund. Your emergency fund needs to be large enough to cover all monthly expenses for the period of time you may likely have no income.

What if I don’t have an emergency plan?

The most important thing is to just get started! Arrange for a debit order to be deducted directly off your salary and paid into an appropriate fund. You may also choose to “kick start” your plan by spring cleaning and selling unused clutter in your home. Exercise equipment is usually a good place to start!