The emergency fund: why it’s so important and how to go about building one for yourself
This is the final blog in a seven-part series on how South Africans can survive a tough economy and build wealth in the face of inflation and price increases. Read other articles in the series here.
An emergency fund is a sum of money set aside to cover unplanned expenses. This means that when the unexpected happens, you can use the money in your fund, instead of dipping into your savings or worse, using your credit card to help you through the financial crisis.
The typical financial emergencies that people face include:
- Losing their job
- A medical or dental emergency (not always their own – often a close relative with no medical aid etc)
- Unplanned travel expenses (often linked to the previous point when family or friends are ill or pass away)
- Car or tyre troubles
- Unexpected pet expenses/ medical bills
- Unexpected home repairs
- ‘Sandwich Generation’ emergencies: unplanned for expenses linked to your kids or parents
Although the last point is a little tricky – we’d argue for example that school fees and school uniforms at the beginning of every year is not a financial emergency – it’s something you know is coming and can plan for. But sometimes things do crop up that were unanticipated – perhaps there is a last minute sports tour for your child or your parents need to move into a retirement home and if you’re not going to say ‘no’ to helping them, then your emergency fund needs to provide you with cover here so that you’re not accessing savings or credit in order to cover these unplanned expenses.
- It may keep you from debt counselling or insolvency
“Most South Africans are living from payday to payday and are barely able to afford their current repayments. One more additional expense – particularly a big one – will send a lot of people into insolvency,” according to Gary Kayle, a Money Coach™ at The Money School. As a result, a lot of people are far closer to this point than they may realise.
- It helps keep your stress level down
Whenever we survey people who are about to start doing one of our financial education courses, we typically find that 60% of them worry about money on a daily or weekly basis. That’s a lot of stress when it comes to just your ‘every day’ money-related matters. Throw in a life emergency like any of those listed above and you go from living on the financial edge straight into your worst nightmare. Being prepared with an emergency fund on the other hand provides you with a financial safety net that will give you confidence that you can tackle any of life's unexpected events without adding money worries to your list.
- It keeps you from making bad financial decisions
There may be other ways you can quickly access cash, like dipping into your bond or borrowing from lenders. Having an emergency fund will not only stop you from making this kind of bad financial decision however, it will also save you significant sums of money in interest, fees and penalties.
You need to save your emergency fund money somewhere where you can’t easily dip into it for non-emergency spending. Keeping this money out of your immediate reach means you can’t spend it on a whim no matter how much you’d like to. We’d recommend putting it into a separate savings or money market account so that you know exactly how much money you have set aside for a rainy day, and how much you may still need to save.
Like most things in life – the exact amount will be dependent on your personal financial situation. Ironically, the better you are at managing your money, the less of it you’ll need in an emergency fund as you’ll find you become better at predicting, and pre-funding many of the expenses that less skilled money managers would classify as a financial emergency.
As a rule of thumb though, we like to recommend people save three months of their salary in
As a rule of thumb though, we like to recommend people save three months of their salary in an emergency fund. But it’ll take most people a little bit of time to reach that goal, so we recommend setting your initial target as a R10,000 safety net and to grow it from there.
“We like to think of your emergency fund as your financial shock absorber,” says Kayle. “Use it to smooth over the effects of the inevitable bumps in the road that happen to everyone and thereby reduce the negative impact on your family.”
The views and opinions expressed in this article are those of the authors and do not necessarily represent or reflect the views of 1Life or its employees.