If anything, Covid-19 has stressed importance of an emergency fund

Facing a crisis unprepared leads to rash financial decisions

25 June 2020 - 09:47
By Didintle Mokonoto
Picture: 123RF/INSTINIA
Picture: 123RF/INSTINIA

If this lockdown has taught us anything, it’s that life is full of uncertainties, some of which can come at a cost.

From small annoyances like having to replace a car battery or fixing a leak in the roof, to more serious concerns like a medical emergency or being retrenched due to the Covid-19 lockdown’s impact on your company, you never know what’s waiting around the next corner.

Didintle Mokonoto
Didintle Mokonoto

You could decide to go with the flow, but this is dangerous, as the old saying goes - failing to prepare, is preparing to fail. Indeed, it’s only when you’re faced with an emergency and no money to deal with it, that you realise how important it is to plan for the unexpected. 

Facing an emergency unprepared also leads to rash financial decisions, like maxing out your credit card or taking a personal loan, both of which could create a cycle of debt dependency and a loan repayment loaded with high interest.

In the absence of a crystal ball that can predict the future, the best defence against uncertainty is to start an emergency fund. That way you’ll be adequately prepared to deal with life’s curve balls, and you’ll earn interest on your savings until you need the money.  

Of course, insurance plays a big role in paying for emergencies, especially serious medical procedures or something devastating like a house fire, but it does not replace the need for an emergency fund.

For example, there will usually be an excess payment for an insurance claim; income protection on a life policy may only last for a limited time; your car’s warranty might not cover all replacement parts; and certain conditions might be excluded due to the countrywide lockdown. It’s best to be prepared for all eventualities.

So, where do you begin?

Start now!

Financial experts have a rule of thumb for an emergency fund — you should save for at least three to six months’ worth of expenses. 

Saving towards such a big goal can be intimidating, which is why it’s imperative that you start now. Start small — even if it’s only R100 a month — and work your way up to your long-term savings goal. In the interim, some savings is better than nothing should an emergency arise. 

Choose a place to keep your emergency fund

An emergency fund should give you quick and easy access to your money, and it should be separate from your everyday transactional bank account so that you’re not tempted to dip into your reserves. When things go wrong, you will need to access the money in a hurry without having to pay a penalty fee for withdrawing the funds.

Your emergency fund should also be earning interest that matches or beats inflation. (Inflation is the general increase in prices over time, relative to the general decrease in value of money.) If you save your money into an account that does not match or beat inflation, your savings will actually lose value.

Most banks offer savings products that can be used for your emergency fund. Before you choose a product, check if the account has a withdrawal notice period and any possible penalties.

Another option is to save using a money market fund. This type of fund is a low-risk investment that earns a relatively high interest rate. Best of all, your cash is accessible within 48 hours of submitting a withdrawal instruction. 

Prioritise your emergency fund

Similar to a retirement annuity or provident fund, it’s important to pay into your emergency fund first before you start paying for other monthly expenses. Allocate a percentage of your take-home income and create a monthly debit order to ensure that you don’t procrastinate or forget to save.

Once you’ve started your emergency fund, you can come up with creative ways to add to it and build it faster. One way is to put all your loose change in a jar. Seriously, it adds up! When the jar is full, take it to the bank and deposit the money into your emergency fund.

Keep at it and don’t stop

You’ll eventually get to a point when you reach your emergency fund goal, but don’t stop there! Your circumstances might change as you go through life, resulting in sudden spikes in expenses. Topping up your emergency fund will make you better prepared to deal with these spikes.

It’s also important to note that should you ever need to dip into your emergency fund, you’ll have to start building it up again.  

All of this sounds very daunting, I know. Saving into an emergency fund requires careful assessment of your monthly financial needs, the creation of a budget, and commitment to keep paying each month. Consider meeting with a qualified financial planner to help you through the process and help you stick to your plan so that you’ll never be caught off-guard. 

* Mokonoto (CFP®) is founder and CEO of YellowBlock.