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Emergency Fund 101

How to Build an Emergency Fund

  • An emergency fund should be set up before you start investing.
  • Use a 32 Day Notice Account + Credit Card if possible.
  • Do not use a TFSA for emergencies, ever.
  • Share your emergency fund strategy with us here.

What Exactly Is an Emergency Fund?

An emergency fund is simply money you’ve set aside for unexpected events in life. A car repair, illness, and unemployment can catch you off guard and leave you financially stranded.

Studies have shown that South Africans don’t save enough for emergencies, in fact, our research has shown that more than half of all working South Africans would not be able to handle an unexpected expense of R10 000 without having to take on debt. This means that when funds are needed to cover an unexpected expense, people often use credit, making a financially bad situation worse.

Your emergency fund is meant to be a buffer for unexpected costs. These might include the following (some things I’ve experienced):

  • Unexpected health care costs, like a hospital procedure for a bony impacted wisdom tooth.
  • Car issues: Alternator needed a replacement, broken windshield, etc.
  • Unexpected house issues: roof leak, broken pipes & subsequent flooding.
  • Unexpected pet costs (my cat “meow meow” developed an allergy and resulted in an emergency visit to the vet.)
  • Job loss (I actually haven’t experienced this, but I know it’s a reality for many South Africans)

When the unexpected happens, it’s important to have a stash of cash set aside in an emergency fund and the reason simple: You don’t know what’s going to happen and no one wants to live at the mercy of life’s twists and turns.

How to Build an Emergency Fund

First, you need to determine how much you need, no point in starting a fund without a quantified goal.

Let’s take an example of Joe Average who takes home R13 990 according to the BDSI Index from this Joe rents a flat for R4 300 and pays R600 for Electricity.

Joe also pays R 1 600 for his car with his fuel bill coming in at R500 per month.

Joe requires internet for his work which is costing him R550 per month for the Telkom and ADSL line and the data. This gives Joe a 4 Mbps line with 200GB of data.

Joe eats for function and not for taste, therefore, he is able to take advantage of VAT-free items by following a Low-VAT Diet and now his monthly food and groceries come down to R73 per day which is R2 190 per month.

Joe took out a Telkom cellphone contract which costs him R300 per month for a Huawei P10 Lite and 2GB of data, in the future, Joe would buy the phone cash but had to opt for a 24-month contract this time around.

Joe has income protection through Liberty and medical aid through MediHelp costing him R124 and R1 360 per month (Further reading on how to choose a medical aid fund).

Joe’s expenses:

Joe’s Income: R13 990

  • Rent: R4 300
  • Electricity: R600
  • Car payment: R1 600
  • Fuel Bill: R500
  • Internet: R550
  • Food: R2 190
  • Cellphone: R300
  • Insurance: R124
  • Medical Aid: R1 360

Total Expenses: R11 524.

That leaves him with R2 466 per month to invest, eat out, treat the girlfriend and most importantly, build an emergency fund with.

How much do you need for an emergency fund?

Depending on who you ask the answer will vary from 2 months to 6 months worth of expenses, personally, I aim for 3 – 4 months, the reason is opportunity cost, I need to put as much of my money to work as I possibly can, so for me I found that 3 months is enough and then I added an extra month to be super safe.

So back to Joe, he decided to be on the safe side and set a goal that he wants enough money tucked away to be able to have a buffer for 5 months should the worst happen – losing his job.

Joe identified Rent, Electricity, Food, Car Payment, Fuel and internet as the most important expenses he would require.  That means he needs R9 240 per month in the emergency fund.

Number of Months Cumulative Expenses
Month 1 R9 240
Month 2 R18 480
Month 3 R27 720
Month 4 R36 960
Month 5 R46 200

Joe will need to save up R46 200 – This might seem like an impossible number, but compared to a new car the amount is not that significant, especially if you approach it with a plan.

Joe now has a goal he will put away some of the R2 396 that he has left after expenses towards the goal of R46 200. How much he will put away depends on him, but he decided to put away a minimum of R1500 per month.

If Joe puts away R1500 per month under his mattress it will take him 2 Years and 5 Months to reach his emergency fund goal. Inflation will eat into his fund so putting it under the mattress won’t be the smartest idea.

Where to put your Emergency Fund?

If you put your money into an account with an interest rate that doesn’t match inflation, your savings will actually lose value. You need a savings account that gives you an interest rate of at least 6.5%. You also need to keep in mind that when things go wrong, you need to be able to access your savings in a hurry.

Keeping this in mind Joe decided to go for a 32 Day notice account, he will use his credit card should he require the funds for an immediate emergency like being rushed to the ER. The other great thing about a 32 Day notice account is that you have instant access that comes with a penalty cost. That’s the beautiful thing about it – instant access when you really need it but “painful” enough that you won’t just dip into it because at the end of the day we need to protect ourselves from ourselves.

Conclusion

Joe is used in the above example to illustrate that whatever you do with finances you need to have a goal that can be measured.

Regardless of your financial situation, you should always put an emergency fund front and center from the first salary you earn, not many people are in the position where they have money like Joe to save and invest, so instead set yourself realistic goals to your own situation and you can apply the same process.

Start with R1 000 then work your way up to R10 000. If you are in a position where you can buffer a R10 000 emergency then you are on the right path.

View your emergency fund like an insurance policy. Once you have it, guard it carefully. It’s not a piggy bank; you should not use it for incidental expenses. In fact, as your salary rises, be sure to up the amount to match your new situation.

Use the fund only in the event of an emergency and hope that emergency never happens.

Newswire

Newswire

The Platinum Wealth Newswire publishes content from opinion pieces submitted by various financial writers, journalists and analysts. Got a story? Send us an email to: news [at] platinumwealth.co.za