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Why an emergency fund is so important

16 July 2020 Schalk Louw, financial adviser at PSG Wealth

We are currently facing unprecedented levels of uncertainty. While many people have lost their jobs, there are also countless others that are still employed, but due to current circumstances, they are either only earning a fraction of their usual salary, or no salary at all.

Yes, emergency measures have been put in place in the form of TERS/UIF during Covid-19, and in the form of standard UIF outside the scope of Covid-19, but the chances of these individuals actually earning their full usual salary even with such measures in place, are fairly slim. For any former doubters, the need for an emergency savings fund is now crystal clear.

The primary purpose of an emergency fund is to cover your expenses for a period of at least six months in case of your retrenchment, dismissal, or any other situation that can prevent you from earning an income. In other words, it is a fund established for the purpose of ensuring that your expenses are covered for a certain period, until such time as you can return to your full income generating ability.

How are these funds invested?

Cash related to an emergency fund is usually saved in a savings account, or in a money market-linked account at a bank. It is imperative that these funds are protected against market volatility, and they should (preferably) be available at short notice, which makes the abovementioned products ideal for this purpose. Growth is earned in the form of interest and your capital is protected against market volatility. It is important to note that interest rates between different banks and between different products, differ.

While a fixed deposit account or a notice deposit account may offer you a higher interest rate, these products are not necessarily the best vehicle to use for your emergency fund. The funds won’t be accessible on short notice, without paying additional penalties. Do your homework before choosing the right product, and be sure to compare the same type of product from various banks or investment companies, before you decide.

How do I get started?

An emergency fund needs to be monitored and revised on a regular basis to ensure that it keeps up with your circumstances, and stays that way. Probably the first and most important step, is to compile a comprehensive budget outlining your monthly income and expenses. This will also give you an indication of your spending habits, and will help you to cut back on unnecessary spending. Once you can see your expenses on paper, you will be able to calculate how much you will need in your emergency fund.

Also consider price increases. If you are starting with this process relatively late in the year, remember that medical aid contributions and electricity costs, for example, increase annually, and also that your municipal accounts may vary from month to month.

The next step is to determine how you will be funding your emergency fund. If you already have the capital available, the process is relatively simple in that you invest it in the product you have chosen. If you don’t have the capital readily available, you will have to work this into your budget through regular contributions. An emergency fund shouldn’t be an investment that you simply dump whatever’s left of your income into, at the end of each month. Rather set up a debit order or a regular withdrawal from your bank account, so that a fixed amount can be allocated to your emergency fund every month. Of course you can transfer any surplus you might have at the end of the month to your emergency fund as well to get to your initial target quicker, but only as long as such contributions are made in addition to your fixed monthly contributions, and they are not the primary source of funding for your emergency fund.

An emergency fund forms part of a comprehensive financial plan

An emergency fund is an investment goal in its own right and shouldn’t be confused or combined with any other investment saving goals, such as saving for an overseas holiday, retirement or a new car. If you feel overwhelmed, however, or cannot see any room for saving towards an emergency fund in your current budget, it is always advisable to consult a professional to assist you, and that can assess your financial situation holistically.

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