It’s Financial Emergency Season — Are You Prepared?
How to overcome the damage a financial emergency can cause
This is an emergency! This is an emergency!
Is it a 911 emergency?
A 911 emergency can cause a financial emergency. But not all financial emergencies are 911 events.
The loss of a job, becoming seriously ill or suffering a major accident will derail the best laid financial plans, as will floods, fires and tornados.
Building levees, firebreaks and bunkers are preparations designed to provide peace of mind for potential natural disasters. Yet, preparations for financial emergencies are rarely given the same care.
The possibility of a financial emergency is always present. But the necessary preparations are delayed, and the stress of “How would we cope?” continues. No peace of mind here.
You may have insurance to cover the situation, but two things are almost certainly true.
- It won’t be enough and
- There will be a delay in paying your benefits.
Whatever your situation, you need to prepare for a financial emergency by building a solid cash reserve (otherwise known as an emergency fund). This is the ultimate preparation for any type of financial crisis.
What is it?
As the name suggests, an emergency fund is a cash reserve held separate from any other financial resources you own. It can be readily accessed as soon as an emergency occurs.
Importantly, rebuilding the emergency fund is a priority as soon as the emergency passes and life returns to (a new) normal.
How large should the fund be?
The emergency fund gives you peace of mind so the fund’s size is up to you. A rule of thumb is to have enough to cover 6 months of your expenses (including debt repayments).
The idea is that 6 months is enough time to recover from an illness/accident, find a new job or sort out alternative living arrangements in the event of a natural disaster.
You may consider that 6 months is too much or not enough in which case you would build your fund to be smaller or larger than the 6-month amount.
But, a word of warning, be conservative. Make sure you identify all the cash payments you need to make every month when calculating the fund target amount. You also must have a sound basis for reducing the amount required if that is your decision.
“We’ll be ok” is not a sound strategy!
Like insurance, you hope you never need to claim against your insurance company or your emergency fund, but it is great to know the support is there if you have to.
Where should you store your emergency fund?
In cash, under the mattress? Absolutely not!
In the event of a natural disaster, your fund could quickly disappear. And you don’t want to be fleeing a disaster with significant wads of cash stuffed into your backpack.
As I stated above, your fund needs to be readily accessible so any cash style bank account with a secure financial institution should be suitable. It may be advisable to split the fund across 2 institutions in case the emergency results in some limitations on access to your accounts.
The temptation is to attempt to earn a higher rate of interest on these funds. But a higher interest rate typically involves a commitment not to withdraw the funds for a specified period of time.
You may be lucky with the timing of your need for cash, but this is unlikely to happen. In an emergency, you don’t want to have to wait (say) 60 days to access the cash you need today.
So, utilising a call deposit account would be the preferred option.
Ok, how do I build an emergency fund?
When finances are tight, it may seem impossible to build a significant fund, even if you are convinced it is necessary.
Here are a few (legal) suggestions. Depending on your situation, you may need to adopt some or all of them.
- Save some of your income. This step is necessary if you want to build a solid financial base in any case. Initially, directing those savings into the emergency fund will start the savings habit. You can direct those savings towards paying off debt or investing when you have reached your emergency fund target.
- Have a garage sale. Most homes have items that are no longer required, so selling these to raise cash is a great way to build your emergency fund.
- Find an extra job. An extra part-time income is a quick way to turbocharge your savings and emergency fund. There are currently many opportunities for casual employment in most areas of the country. Taking advantage of these should not be difficult. I’m not suggesting this as a long-term career change. However, I have seen cases where the extra job was so attractive that it did turn into a more permanent additional source of income.
And let’s address the “I won’t work for (say) $15 per hour”. I urge you to remember that -
- this is just a short-term project to build the emergency fund and
- $15 per hour is more than Netflix pays you while you binge the latest series of Bridgerton.
When do I use the fund?
Hopefully, the short answer is “rarely” — it’s even better if the answer is “never”. Remember, like insurance, you hope you never need to make a claim on the fund.
Emergency situations should not occur very often, so withdrawals from the fund should not happen very often either.
The financial consequences of natural disasters would qualify as would the previous examples of a loss of a job or a serious illness or accident.
But what about replacing a household appliance that fails unexpectedly? Ideally, that would not qualify as an emergency, but the fund could be used if the funds are replaced within 2 or 3 months.
And a car is written off unexpectedly? The key here is “unexpectedly” so the fund could be used to cover the replacement but again, speedy replacement of the funds is necessary.
Following that logic, any payment that could have been foreseen would not qualify. A large utility bill, school fees or even the planned replacement of a car need to be covered as part of general living expenses if the purpose of an emergency fund is to be maintained.
Let’s get it done
An emergency fund is an integral part of a balanced financial plan. It is designed to provide you with peace of mind, which takes some of the stress out of your financial life.
Having the discipline to build and maintain an emergency fund will positively affect your attitude to managing your finances.
