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Emergency fund: What is it, and how do you set it up?

Posted 05.07.2020
Emergency fund: What is it, and how do you set it up?

Having an emergency is something we can all understand. What happens when you urgently need money but your pockets and bank account are empty? The answer to that is you get stressed, desperate, and you might even face failure. 

So many bad things can happen if you don’t prepare for any crisis. But, this is where an emergency fund comes in. It allows you to be smart, save money, and plan ahead. In essence, you become your own superhero by saving yourself on rainy days.

Emergency fund: What is it?

In simple words, an emergency fund is money that you keep in an account. This money is saved specifically and only for unplanned costs that happen in life.

Emergencies can happen at any time

When you create a budget for monthly expenses, you often write down the things you know about, like your grocery and transport costs. What about the things that you don’t know about? These are the things that demand your money, and yet you didn’t plan for them. 

Examples include falling sick and having to pay for medical bills or having your phone stolen, and now you have to buy a new one. In more serious situations, you can even lose your job or source of income. In such cases, you might not have the cash you need to survive while you look for other ways to make money.

Why is an emergency fund important?

In South Africa, it is normal for people to live from paycheck to paycheck. So, when they now have to pay for things they didn’t budget for, they usually borrow. However, borrowing or taking a loan or using credit cards are not perfect solutions.

You can find yourself in a negative cycle of always borrowing money and having to pay it back. Besides, this can get super expensive because you may also have to pay interest each time you borrow money.

By saving money and putting it into an emergency fund, you can remain independent and on top of things during emergencies. Even when there is no emergency, you still have peace of mind knowing you are at least prepared just in case something does happen.

How do you create an emergency fund?

Keeping your saved money in your mattress at home is never a good idea. Instead, you can set up an emergency fund by opening an account. Most banks and financial institutions can be trusted to keep your money safe. You can keep your emergency fund in the following types of accounts: 

Savings account

As the name suggests, a savings account is the perfect place to build a nest egg. Money that you put in a savings account gains interest over time. However, you can’t use the money on a daily basis, although you can still make withdrawals.

Additionally, in your agreement with the bank, you may be required to make monthly deposits. There are also high yield savings accounts that are insured.

Transactional account

This is the account you use in your day to day financial dealings. For example, this is the account where you usually receive your salary or income. You can have a separate transactional account where you keep your emergency fund. However, most transactional accounts have monthly charges, and your money will usually not gain any interest.

To find out more you can also get help from an experienced financial adviser on other ways to create your emergency savings fund. 

How much money should you put in an emergency fund?

When you start saving the money, it takes time to build your emergency fund. The best thing is to have an end goal in sight and work slowly towards that. At the end of the day, you should have enough money saved to meet your needs in an emergency.

Some experts say that you should save at least three months of your salary. In contrast, others say your emergency fund should have enough money to last you six months when you’re not working. But only you can decide the amount of money you can afford to save and how long it will take you. You can use the following ways to save money:

  • When you budget, put money aside every month. Even if it’s only R100 or R50 it adds up and your emergency fund will eventually grow.
  • Save your loose change. When you have extra money lying around, don’t think of ways to use it. Put it in your emergency fund instead.
  • Set up a debit order. As an example, you can have some of your salary or income automatically transferred to your savings account/emergency fund. This reduces temptation and saves you time and effort.

Benefits of an emergency fund

  • it keeps you disciplined and organized in the long term;
  • it teaches you the proper way to handle personal finance;
  • you don’t have to borrow money every time you meet an emergency;
  • there is peace of mind from knowing that you have backup money in an account; and
  • you can earn more money with your emergency fund via reasonable interest rates.

Make sure your emergency fund has the following attributes:

  • Accessibility – You should always be able to access your money when you need it. The worst thing that can happen is being unable to withdraw the money or use it because of some regulation on your account that you didn’t know about.
  • Increasing value – If your emergency fund is not gaining interest at the least, make sure it’s not losing value from inflation.
  • Safety – Keep your emergency money with an institution that is registered and has a good reputation. 

Photo by Zach Vessels on Unsplash