The coronavirus pandemic may have served as a wake-up call that life can be unpredictable, contingency plans should be put in place to help mitigate uncertainties. An emergency fund should be part of your financial plan.
What is an emergency fund?
Many people prefer to be optimistic, focusing on short-term positives, rather than negative potentially long-term situations. This can include fender benders, job losses, geysers bursting and medical emergencies; they can be seen as an inevitable part of life.
So, it’s worthwhile considering drawing up a solid financial plan that makes provision for unplanned expenses. A knowledgeable independent financial adviser would typically advise you to implement an emergency fund as a starting point for your portfolio and explore investment management options as you progress.
An emergency fund can provide you with unrestricted access to money, safeguarding you from needing to consider abandoning long-term financial growth plans when unforeseen expenses threaten your financial wellbeing.
Think about liquidity
The downside to cashing in long-term investments to assist you during a financial crisis or market downturn may mean selling at a low price and actually ending up with less money than you contributed. An emergency fund can help you avoid this potential threat to your financial health.
An emergency fund should be placed in a vehicle that aims to preserve your investment over the short-term and can be retrieved easily. There are numerous products such as fixed deposits and other notice accounts that may offer a slightly better interest rate but are impractical in situations where you may require an immediate solution.
It’s worth considering parking your emergency fund into a low-risk investment such as a money market fund; its mandate aims to provide better returns than a normal bank deposit and it allows for instant access to the money.
Setting a realistic target
When it comes to personal finance, targets should always be molded and set according to your financial circumstances. There may not be an exact rule, but an IFA would generally suggest that your emergency fund is large enough to cover at least three to six months’ monthly expenses.
The total amount should be enough to keep you afloat during a crisis. It’s important to note that money in an emergency fund should not be used for things that you want e.g. a vacation. It shouldn’t be used to fund medium- or long-term goals.
Review your fund regularly
Your emergency fund should be reviewed regularly, alongside your overarching financial plan, as it’s likely that your income and expenses will change over time. The main factor that should be considered when re-evaluating is inflation. It can be said that the bottom line is that your emergency savings ought to be enough to fund your current lifestyle.
How to get started
Thinking about the possibility of saving at least three months’ salary may seem overwhelming, but this shouldn’t deter you from getting started. It’s typically encouraged that people who are paying large amounts of debt start their fund as the debt is reduced.
Have you thought about starting to build an emergency fund? If not, try and begin as soon as possible. Speak to an IFA who can help you by objectively analyzing your financial situation, set realistic targets, and implement ways to ensure you achieve them.