Saturday 18 July 2015

What is an Emergency Fund and Why You Should Have One

What is an emergency fund? It is cash that you have saved up just to settle some unexpected events or accidents that life hands to you. How much should you have in an emergency fund? That depends more on your current situation, such as being self-employed or employed in a high turnover industry, but one guideline that I like to follow is around 8 months of expenses, which I got from Suze Orman. More on why and what an emergency fund should be made of will be covered in this blog post.

(Image source: http://www.inc.com/magazine/201405/alexa-von-tobel/need-for-freedom-fund-savings-living-expenses.html)


Why is an emergency fund so important?

There are many accidents or events that may be able to throw your life into disarray if you do not keep some spare savings. Some of the events that may arise include:
  • Retrenchment
  • Medical Emergency
  • Car Accidents
  • Household Appliance Spoiling
These events would definitely affect your budget for the month and having an emergency fund will provide a buffer of sorts to help reduce their impact. This is definitely helpful especially in the example of being retrenched where an emergency fund will help buy you some time and give you greater confidence when finding a new job.

What should be in an emergency fund?

An emergency fund should have an adequate amount of savings to tide you over an emergency, this varies for different people. If you're in a stable industry with a steady job and income, you can afford to have less in your emergency fund, while being self-employed or in a high turnover industry with low job security and unstable income will necessitate a larger emergency fund simply due to the higher possibility that you will draw on it more often.

An emergency fund should consist of cash or financial instruments easily liquidated into cash, such as fixed deposits or even the new Singapore Savings Bond (more info in link). It should NOT consist of stocks, bonds with long maturities (more than a few months) or anything that may be devalued under any reasonable circumstances (barring any extraordinary events).

Right now you may be thinking that in this case, you're losing a chunk of potential returns that you could earn if only you invested the emergency in the stock market or putting them in longer term bonds with higher interest rates, but the specific intention of having an emergency fund is to allow it to be drawn upon at a moment's notice as we can almost never predict an emergency.

Hope this blog post has been able to convince you of the importance of having an emergency fund as well as cover what an emergency fund should consist of. If you want to find out how to start building your emergency fund, you can look at 5 Ways to Start Building Your Emergency Fund

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