In today's times, with common occurrences of economic turbulence, it is of vital importance to have an emergency fund in place to ensure that you and your dependents are financially protected against unexpected, adverse events that may impact your short-term financial wellbeing and stability.
These events may be a loss in employment, an incurrence of major health expenses, or the need for car or home repairs. As reported in Old Mutual's Savings & Investment Monitor 2022 survey, only 39% of South Africans have enough money saved up to last for at least three months if they were to be retrenched or lose their job. 40% have had to borrow money from friends or family when needed. (1) These statistics indicate that many South Africans suffer financial strain when faced with an emergency, as they are not financially prepared for it.
An emergency fund can allow for financial cushioning if you were to experience an unexpected pause in income or a spike in expenses for a short period of time. This allows you to avoid outsourcing funds through loans, where you may be subject to a high cost associated with borrowing due to the interest charged. It also helps prevent the need to withdraw money from your long-term savings such as your retirement fund, which is an important savings vehicle created for the purpose of saving towards a comfortable retirement.
Consider a scenario where Kiara, a 30-year-old individual earning R10 000 per month, starts to contribute R500 towards her short-term emergency fund every month. The account earns 8% interest per year. Three years later, at 33 years old, her emergency fund amounts to R20 313*. At this time, an emergency event occurs where she needs R20 000. Kiara is able to immediately access her savings and use it towards this emergency.
In an alternate scenario, Kiara, has not saved towards an emergency fund and is in immediate need of R20 000 for an emergency. She is considering taking out a personal loan for this amount. She considers paying the balance over five years with monthly repayments of R500 starting immediately. At an interest rate of 20% per year, this would ultimately lead to Kiara paying back a total amount of R20 000 (i.e., the original loan amount) plus additional interest of R10 414 over the term of the loan (i.e., the total repayments amounted to R30 414).** This would result in Kiara not only being in debt, but she may also pay a significant amount of interest due to the high cost associated with borrowing while incurring additional fees during the process.
Kiara is also considering the option of resigning from her work to immediately access her accumulated retirement fund savings (currently at R60 000 at age 33), instead of taking out a loan. If she withdraws R20 000, she remains with a total of R40 000 which she could then transfer into a new retirement fund, with her new employer if she is employed by a new employer and choses the option to transfer her benefit. Her projected retirement savings at her planned retirement age would now be estimated to be R295 782, whereas it could have been R328 911 if she did not resign from her initial employer and withdraw from her retirement savings fund.*** This is a difference of R33 129, which means that Kiara could be set back from reaching her retirement savings goals, leading to a negative impact on her income in retirement. If she was not able to immediately find another place of employment after resignation, this impact would be exacerbated. She may also be taxed on withdrawing her savings as a cash lump sum, further negatively impacting her long-term retirement outlook.
It is generally recommended to start saving towards an emergency fund as soon as possible. To enable this, you should aim to reduce unnecessary expenses as far as reasonably possible and set aside a portion of your income on a regular basis, e.g., monthly, for this purpose - an amount that is affordable given your own personal circumstances. This will allow for funds to gradually build up over time, which will help ensure that you are better positioned to meet unexpected expenses, should they arise. This emergency fund should be kept in an easily accessible, low-risk and low-fee account and the fund should ideally amount to at least three to six months' worth of living expenses (2). The amount of money in an emergency fund should be sufficient to meet your needs depending on your lifestyle, monthly expenses, income and dependents.
Look to start building up a healthy emergency fund today to help protect you and your loved ones from financial strain in the event of an emergency.
* The effect of tax and charges are ignored. Payments are made monthly in advance. The account allows for immediate access
of funds.
** Charges and other related fees are ignored. The loan is repaid monthly in advance.
*** Calculations are based on the following assumptions: 33-year-old female, earning R12 250 per month after tax at this
age, retirement age 60, R500 monthly contribution, 8% net nominal return p.a., employer makes no contribution towards
retirement savings, retirement contributions are assumed to increase yearly with salary inflation until retirement age, tax not accounted for, calculation done in arrears and assumes that the exact same contribution pattern is made at her new job.
Projected retirement savings fund values are shown in today's money.
1 Old Mutual Savings and Investment 2022 survey
2 https://www.wellsfargo.com/financial-education/basic-finances/manage-money/cashflowsavings/emergencies
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