As part of your budget and personal spending plan preparation you should aspire to putting aside a little extra cash towards building up an ‘emergency fund’.
What is an emergency fund?
Have you ever had those times when life happens and an event strikes you out of the blue that costs you money?
This could be an event such as your car breaking down, a medical emergency, additional school funds, home repairs or even a more serious event such as job loss.
So what are the consequences of not having an emergency fund? Many people have no choice but to resort to borrowing the money. This means that they may dip further into the credit and debt spiral.
If there is another emergency or sudden event this will just compound the situation and increase the debt burden further. So the vicious spiral goes.
An emergency fund is exactly what it says it is – a separate fund dedicated to meet any emergency eventualities that one may incur from time to time.
How do I create an emergency fund?
You can start small or start with what you can afford. The important thing is make a start. Don’t procrastinate and divert the funds elsewhere. Slot the emergency fund payment into your budget and make it a regular monthly contribution discipline.
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Where should I invest it?
Typically you need something that is liquid. You need something that you can access fairly easily but have it just far enough out of reach so that you don’t be tempted to plunder any of the accumulated capital too easily.
You want something where the investment risk is low so that the capital is not eroded but at the same time there will be a little bit of growth.
The most likely facility for an emergency fund would be a 32-day notice deposit account or a suitable money market investment vehicle. These are available through most financial institutions.
How much should I accumulate in my fund?
The general rule of thumb is that at all times the capital in your emergency fund should match 3 – 6 months of gross monthly expenses.
If at any stage you dip into it you must ensure that you bring it back up to these levels again.
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An emergency fund is an important part of your personal financial planning. It will give you piece of mind that should an emergency strike that financially you will be able to meet the challenge.
Remember, the cost of not having such a fund will mean that you could very well incur the cost of credit if you have to borrow the money.