Following the pandemic, you would be hard-pressed to find an investor who disagrees with the rationale for having an emergency savings fund. However, the higher inflationary environment is putting a fresh spin on the topic. Against this, how should investors approach unexpected expenses in 2023?
The New York Times recently reported that a growing number of workers are getting access to a new job benefit: help with saving for unexpected expenses. The financial stress on workers brought about by both the pandemic and rising inflation, as well as employers’ need to attract employees in a competitive job market, is making rainy-day savings a hot job perk, with companies like Starbucks announcing emergency savings options for workers.
But if you don’t have access to such a perk, what is the best way to plan for an emergency fund? How much should you set aside, and how can you ensure your money grows in a high inflationary environment?
Below are insights from three individuals at Allan Gray, who are at different life stages, and on different financial journeys, on how to approach emergency savings in 2023.
Sandy McGregor, who has been at Allan Gray since 1991 and is a fund manager, believes that investors always need to have at least some financial buffers to cater for the unexpected, such as a health crisis (which can be addressed through a medical aid), or suffering sudden losses (which could be addressed through insurance policies).
“There is a widespread practice to fund difficult-to-anticipate losses through short-term borrowings, which are relatively easy to access. However, compounding interest payments on such loans can rapidly become a serious burden, especially in today’s higher interest rate environment. Accumulating a precautionary financial buffer is a better way to go,” says McGregor.
Gladness Rupare, an investment specialist and parent, believes it is crucial to look at your finances holistically, set goals and allocate funds accordingly.
“Emergencies have to be prioritised, but contributing to retirement, your children’s education and/or other longer-term investments is also important. Time is a key ingredient for long-term investment success – the more time you have, the more you will benefit from compound interest. Emergency savings should, therefore, not deter or delay longer-term goals but should complement carefully designed short-, medium- and long-term objectives.”
Emily Gray, a newly married business analyst, is actively saving towards an emergency fund, which would be used to fund significant expenditure that is out of the scope of her ordinary monthly bills – for example, car troubles, uncovered medical expenses or replacing a damaged or stolen important item, like a phone.
“I would also draw from my emergency fund to temporarily fund a claim that my insurance – medical or other – is expected to pay out in time. It is additionally a useful short-term buffer in the event of a loss of income,” says Gray.
Gray agrees that saving for her emergency fund is as important as saving for her retirement.
“I have a monthly debit order set up for my emergency fund, which ensures that I save consistently. I also try to increase the allocation slightly each year.”
Both Gray and Rupare save for an emergency via a low-risk money market unit trust. Rupare recognises the importance of separating her savings from her day-to-day transactional account, so she isn’t tempted to use it unnecessarily. Gray is comforted knowing her hard-earned rands will earn some return, as putting money away here means she gets it back, with a sliver more.
“Since a money market fund can take a day or two to pay out, I have a credit card to cover any immediate expenditure, which I would then pay off with funds drawn from the unit trust,” says Gray.
On the issue of how much is appropriate, McGregor says this is tricky to answer.
“Perhaps the simplest metric is, at the end of a month, after all routine commitments such as rent and mortgage payments have been met, an amount equal to two months’ normal expenditures. Many find it difficult to achieve this, but it is a good aspirational target.”
For Gray, her goal is to reach three times her monthly salary (net of tax). This target originates from the concept of an emergency fund being an important short-term buffer in the event of a loss of income.
Rupare’s savings goal is the same as Gray’s, but she is eyeing nine times her monthly salary.
“I’m still a way off my maximum target; this might take me another five years to accomplish, however, I am comfortable with where I am currently,” notes Rupare.
Rupare says that even though approaches may differ, the takeaway is this: An emergency fund can help investors get through unexpected and difficult situations. It is therefore important to ensure it is significant enough to cover basic expenses for a length of time.
“Putting money away is hard, but even small amounts add up over time. The last few years have shown us how important it is to be crisis ready,” concludes Rupare.