An emergency fund is a lump sum of money that is important to set aside to cover any financial surprises, such as car breakdowns, medical requirements, home repairs, vet bills, or sudden unemployment. These unexpected emergencies can be stressful, costly, and they often demand immediate payment.
You can financially manage these unanticipated disasters by ensuring you have an emergency fund to fall back on when the need arises.
Insurance can play a big part in financing emergencies, but it still does not replace the need for an emergency fund — your medical aid provider might not cover every expense; warranties come with a timeframe; and your home and car insurance policies may still require you to pay excesses.
You should, therefore, regard your emergency fund as an additional insurance policy that needs to be kept solely for emergencies, rather than dipped into for incidental expenses. Even if your income increases, it’s advisable to increase the amount you save for your emergency fund too.
In addition to the financial stability, there are other benefits to having an emergency reserve of money. Having a financial safety net can give you the confidence of knowing that you can tackle whatever life throws at you, which can help to keep stress levels at bay. An emergency fund can also prevent you from making bad financial decisions in times of crisis, such as borrowing a lot of money at a high interest rate, with fees and penalties. Having an emergency fund is arguably a necessity nowadays to save you on a rainy day from having no choice but to go into a lot of debt.
Studies have shown that many South Africans sadly don't save enough for emergencies, and when faced with unexpected expenses, people often use credit that they can’t easily repay. Many people don’t save for emergencies because they don’t believe that something will happen to them, or they are not wholly aware of all the costs involved if the unforeseen does happen. Emergency savings are often not given priority as people tend to put their money towards short-term gratification or long-term goals. It is also understandably easier to save for positive events, such as a holiday or retirement, rather than prepare for the negative.
How much to save
While anything is definitely better than nothing, most financial experts recommend that you aim to grow an emergency cash reserve that would be large enough to cover all of your expenses for three to six months. The exact amount may depend on a few variables, so it’s advisable to arrange a meeting to discuss how your emergency fund could fit in with the rest of your priorities.
Saving for an emergency fund can require a bit of effort to achieve. The first step is to figure out how much you spend each month — accommodation, food and transport are likely to take up most of your budget — then multiply that number by three and you can set that amount as an initial three-month target.
How to save
There are many ways you can approach saving for this goal. For example, cutting back on the amount you spend on eating out can help to fund your savings plan. The key is to add to your emergency fund at regular intervals, and you can do this by dedicating a feasible amount from your paycheck and treating it like any other recurring bill that you need to pay each month. Saving a raise, bonus or tax refund, will also give a healthy boost to your emergency fund, as will downgrading your mobile phone service or trading in your car for a cheaper model.
If funds are a bit tight, you can start simply by emptying your pockets each day or tipping yourself whenever you eat at home, and stashing the change in a jar. If you manage to dedicate ZAR50 per day to your effort, you'll have ZAR18,250 by the end of the year, which will add up to ZAR91,250 in five years!
This is when it helps to have a financial planner/coach helping you to create the saving behaviour change - and then keep to it!
Banks offer a range of savings accounts that may appeal to you. However, you should discuss whether there are any notice periods, possible penalties or minimum deposit requirements before going ahead.
Alternatively, you may wish to put your emergency savings into a money market unit trust fund or a high-interest savings account, as they are low-risk investments and accessible (although harder to dip into than a jar, your funds can be accessed in between 24 to 48 hours with no penalties), and you can also earn an interest rate on the money, which can be reinvested to keep up with inflation. A low-risk fund, however, does still carry the opportunity cost of putting your money in an investment that could be earning a higher return in a riskier investment.
Funds with a higher risk profile, such as a low-equity multi-asset fund or a bond fund, will generally earn a higher return than a money market fund. And you could select these funds for emergencies that are prone to above-inflation price increases, such as medical expenses. However, do bear in mind that if you choose this option, there is a risk of capital loss, as these funds are more volatile than money market funds. It is, therefore, advisable to invest for a longer term to reduce your chance of losses. You’ll find that each unit trust fund has a recommended investment period so that investors can maximise the benefit of that fund.
The amount of money required to fund a proper emergency fund is significant but necessary as we live in uncertain times with an uncertain economy. If you don’t have a rainy day fund already, start saving now and put aside whatever you can, even if it isn't much. It will allow you to weather those rainy days without running up unnecessary debt. Be prepared — save towards an emergency and don’t hesitate to discuss how best to allocate your savings to appropriate investments.