03 Jun Step by step: How to build an emergency fund
Part of a sound financial plan must include an emergency fund, because without it, your financial plan can be derailed should an emergency arise. An emergency fund is an account where money is set aside for any unexpected events of life. These events can be stressful and costly.
A tyre burst, paying medical bills that were not covered by your medical aid, losing a job, paying for the funeral of a family member who did not have a funeral benefit or not getting paid on time as a freelancer are just some of the events that can catch you by surprise, and if you don’t have an emergency fund, it is easy to turn to personal loans, credit cards and overdraft. While these may provide a short-term solution, the long-term effects of them are too costly i.e. high-interest rates of borrowing.
How much you should have in your emergency fund is dependent on your personal circumstances but it is recommended that it should be able to cover least six months worth of your living expenses.
If your living expenses are R10,000, it means that you should have R60,000 in your emergency account. This means that you need to know exactly how much money it costs to run your life every month, and you can only know that by budgeting.
To save for an emergency fund, you need to set a goal for yourself: how much do you wish to accumulate in the fund? Then come up with an action plan on how you will build up your emergency fund:
- You can save a fixed amount every month; whether this is R500 or R5,000, let it be an amount that works for you
- If you are a freelancer or earn on commission, perhaps a more practical approach would be to save a percentage of your income
- One of the quickest ways to beef up your emergency fund is through a cash windfall; you could save a percentage of your bonus or even a tax refund.
The best and most efficient way to ensure that you do save for an emergency fund is to automate your savings. This could mean setting up a monthly debit order until you reach your emergency fund goal.
What kind of account to use for an emergency fund?
An emergency fund is just another form of a savings account. It is money set aside for future consumption and is readily available. Because an emergency is an event that can happen at any time, the fund needs to be liquid, meaning it should be accessible with little to no risk of losing money and it must not carry expensive penalties. This can simply be a different bank account from your normal transactional account or a money market fund, both of which are for the short-term, for example, a 7-day notice or a 32-day notice. Just make sure that the chosen bank account can at least give you an interest rate on par with CPI of 4.5%, or better yet, one that beats inflation. So do not be afraid to shop around the different banks for a decent interest rate.
An alternative to saving in a normal bank account or in a money market account is to stash your money into your access bond. By putting extra money into your bond, the interest you pay on your bond is reduced, but the access facility means that the excess funds are available for you to withdraw should an emergency arise.
For this option, you will need to know what type of bond you have; is it an access bond or not? If you do not have an access bond but need to access the money that you have paid into your home loan, you need to apply to your bank to do this.
I would suggest that you check which type of bond you have with your bank even before you start saving for an emergency fund in your bond.
Emergency fund takeaway:
- To reach your goal, you need to automate your emergency savings
- The emergency fund needs to be liquid, meaning it is easy to access and you will not lose money.
An emergency fund does not only provide a financial buffer for the unexpected events of life, but it also prevents the debt-trap or debt-dependency. Having an emergency fund allows you to plan for the future without being scared of what might happen. It puts you back in the driver’s seat knowing that if a financially demanding event happens, you and your family are covered.
Tribe, do you have an emergency fund? How did you build it up?
This article first appeared in City Press