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Emergency fund for a rainy day

By unknown | Jun 09, 2009 | COMMENTS [ 0 ]

DOWNSIZING, rightsizing, forced retirement, lay-offs, firings, outsourcing and being made redundant.

DOWNSIZING, rightsizing, forced retirement, lay-offs, firings, outsourcing and being made redundant.

All the above could mean the same thing to you: financial catastrophe.

No, you may not have to declare bankruptcy or move back in with your parents, but losing your job could put a big dent in your financial goals and even set you back several years.

You may need to live on your savings or liquidate some of your investments.

If you have no savings or investments, you may have to rely on credit cards, which could rack up significant credit-card debt.

Then when you find a new job, your expenses may have increased because of the additional payments on your credit card.

And the job you eventually find may not pay as much as the one you lost. So you may now be forced to live on less money while your expenses have either continued at the same level, or even gone up.

Studies have shown that the average worker will have six career changes in his or her lifetime. Not just job changes but career changes.

So how can you prepare for your own financial "downtime"?

An emergency fund.

An emergency fund is really only savings but it is not savings for a particular item or even an investment for your future or your retirement.

It is your "rainy-day" fund. But unlike insurance, where once you pay your premium the money is out of your hands, your emergency fund is yours to keep.

So how much do you need? How can you build your emergency fund? And where should you keep the money?

The easiest way to figure out how large your emergency fund should be is to take your current income and multiply that by the number of months you could be out of work.

If you make R3000 a month and you want to be prepared for a six month "vacation", you will need R18000.

But obviously, saving R18000 will take some time. How quickly you want to build your emergency fund depends on how concerned you may be about your current and future employment prospects.

Saving R100 each month will take you 180 months or 15 years. Saving more money each month means you will be protected sooner. Also, consider that during the next 15 years, your income may increase and your expenses usually rise to match your income.

Also consider inflation. If you own your home, your house payment may not rise. If you are renting, your rent probably will. The cost of food, utilities and taxes also rise over the years. At the inflation rate of 8,4percent, after 15 years your R18000 will buy you much less.

A good rule of thumb for saving is to try to save enough money each year to supply you with one month's income. This means you are saving 1/12 or 8,3percent of your monthly income.

This will allow you to build your emergency fund by one month every year. After only six years, you will have a six-month supply of emergency cash. Then you can continue to extend your "coverage-period" or you can divert the monthly payment into other savings or investments.

Most people find that "billing" themselves for savings and investments is a good way to put your savings on auto-pilot.

If an amount is taken automatically from your bank account each month, it is easier to handle than if you wait until the end of the month and try to save from what you have left over.

How often do you have anything left over at the end of the month?

So where is the best place to keep your emergency fund?

Probably not a place where you can have easy access to it. Definitely not as cash in the cookie jar. That is too unsafe and you won't earn any interest.

Savings accounts are okay, but usually they pay very little interest. If a savings account is your choice, don't open one at your regular bank. Also, don't get a current account to avoid the temptation to spend "just a little" here and a little there.

Or look for a money market account that pays a reasonable interest rate. You may want to consider a money-market or other such account that only invests in tax-free securities. This way you won't have to worry about paying taxes on your interest.

Then set up an auto-withdrawal from your regular current account from your pay check right into this new account.

Adjust your budget to accommodate having less money each month and forget about it.

You can also give your emergency fund a boost now and then by putting "windfall" money into it. You know, money such as birthday gifts, inheritances, insurance settlements, tax refunds and so on.

Your emergency fund becomes your own financial insurance policy. And if you never use it, you will have that much more money to play with when you retire. Or even retire early with the extra money you have saved. - simplejoe.com


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