“Every time you borrow money, you’re robbing your future self.”
Nathan W. Morris
If you want to put your personal finance life in order, you have to do two things; make a budget and set up an emergency fund. These form the foundation for lifelong financial freedom.
The budget brings your entire personal finance strategy and implementation together helping you live within your means and achieve your goals. But what is an emergency fund, why do you need it and how do you set it up?
What Is an Emergency Fund?
An emergency fund is a general term for the money you set aside to cover for emergency expenses. These savings help you cover for your expenses when the emergency arises so that you don’t have to rely on debt or cutting back essential expenses like food or rent.
Why Should You Have an Emergency Fund?
First, so you don’t get into debt; and second, so that your lifestyle is not affected.
Unforeseen expenses can ruin your budget (whether you have a budget or not). Everybody has a plan for what they will do with their money. When an emergency hits, you are forced to change or postpone those plans. If that is not possible, you are forced to take up debt. And this will significantly slow down your financial progress.
If you have money set aside for emergencies, that is not the case. Saving for emergencies is forward planning to ensure that your lifestyle and finances are not disrupted when an emergency strikes.
How Do You Build an Emergency Fund?
Rome was not built in one day and your emergency fund won’t be either. Regardless of your financial situation, you can do something to build up your emergency savings. Here is a 3-point plan to build up your safety net:
- Slash spending – Cutting unnecessary expenses, especially impulse buying, will give you some extra cash to save.
- Save monthly – Setting aside a fixed amount to save to your fund on a monthly basis will help you build up your fund. Set reminders and, if possible, standing orders so that you can remember.
- Save Windfalls – We don’t mean you have to wait to win the jackpot so you can save. Every time you get unexpected income that you had not projected in your budget, save it in the fund. Should you win the lottery, save some of it too. 😊
How Much Should You Save?
Set yourself three targets: three months’ expenses, six months’ expenses, and one year expenses.
Three months’ expenses are the minimum and you should try and get to that level as soon as you can. Such a fund can handle a one-off expense but might not be able to sort major or recurring expenses. If you lose your source of income, for example, the expenses will be recurring every month. That’s why a six-months fund is considered the optimal one.
Once your fund can cover six months’ expenses, you can go easy on the savings towards the fund and start saving for other goals. If you can, continue building your fund, at your own pace, until it can cover one year expenses.
Where Do You Keep the Emergency Savings?
Where you keep your savings is very important. You should keep it in a flexible, liquid, and interest-earning account.
The account has to be flexible to allow you to save at your own pace. An account with restrictions on the amount you can deposit or the frequency of depositing is prohibitive because they don’t take into account your specific financial situation. You need an account that enables you to save any amount, at any time and stop making deposits when you reach your target.
The account should be liquid meaning you can access your funds within a short period. When an emergency hits, you should be able to conveniently access your funds within the shortest time possible regardless of where you are.
The account should also earn you interest that compensates you for inflation. If it does not, then it means that your money is losing value, and you will find it difficult to make ends meet every year.
The Zimele Savings Plan gives you that flexibility, liquidity, and growth (interest).
When Do You Use the Fund?
It is normal to feel tempted to use the money you have saved for emergencies. Don’t do it. Use this fund only in case of a true emergency.
What, then, is a “true emergency’? These are major unexpected expenses. That’s the criteria; major and unexpected. These can include emergency travel, medical expense, major and unexpected car repairs, or failure of a major appliance or furniture.
If the expense is not major AND unexpected do not use the emergency fund. School fees is a major expense but it is not unexpected. Everybody knows the school fees expected every term/semester. Regular car repairs and maintenance are also major expenses but are also not unexpected. On the other hand, if your earphones or toaster stops working, it’s an unexpected expense but hardly an emergency.
For major but expected expenses like school fees and car maintenance, save for them specifically every month.
Set aside money for miscellaneous expenses on your budget to cover unexpected but not major expenses. If you don’t spend the money you set aside on a specific month, save it in an emergency fund or keep it to use for similar expenses when they arise. You might use it to refill your gas for example.
Conclusion
If you want to achieve financial security, you MUST have an emergency fund. It not only helps you prevent debt but also gives you the freedom to take measured risks. If you have money set aside to cover expenses for one year, you are able to start a new business without having to spend sleepless nights worrying about your income.
Should you lose your employment or if your income becomes volatile or uncertain, your emergency savings can provide a steady income through the interest earned. The Zimele Savings Plan allows you to do just that with the Income Plan.
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