An emergency fund is one of those high-priority investments that everyone must have in life, since it provides you with a financial buffer to cover short-term expenses when unexpected events happen. Not having one leaves you vulnerable to paying exorbitant interest rates on a credit card or bank loan when money is suddenly needed for an unexpected expense. The rule of thumb is to accumulate 3-6 months of your gross salary for emergencies, but how do you get there, and what do you do once there?
When building up an emergency fund, it makes sense to invest in an accessible option like a unit trust that prioritises both capital protection and liquidity. A money market fund, for example, allows you to accumulate your savings to reach your emergency fund goal while giving you attractive returns for low-risk investment growth and you can access it at any time which of course is the key component of any emergency fund. As alternatives, bank savings accounts only offer exceptionally low interest rates and fixed deposit accounts might prove inaccessible for emergencies and therefore unsuitable.
What happens once you reach your goal?
If you’ve reached your goal of saving say three months’ worth of salary, why not continue to contribute to it until you’ve saved six months’ worth of salary? Either way, once you’ve reached your goal, your emergency fund should be left alone to continue to grow, until you really need it.
Remember that you will need to top up your emergency fund if you dip into it along the way.
It’s important to have short, medium and long-term investments.
To maintain a healthy financial life, you need all three: short, medium and long-term investments. Your short-term timeframe is covered if you have an emergency fund; medium term financial goals may take more time to build and could provide for a deposit on a home, or to pay for your child’s education. Your long-term investment is mainly for a secure retirement, and typically takes decades to accumulate successfully.
Making provision for each of these goals at the same time is not always realistic or affordable. If you feel stuck as to where to focus or have limited money to invest, getting your emergency fund in order is a key step. From there, you can invest for longer-term goals without having to worry about a financial emergency preventing you from maintaining your budget or investing towards your future. As is true with so many things in life, the earlier you start something, the more time you have available for progress, and you may even reach your goal sooner rather than later.
Financial stability and ultimately, independence, are worthwhile to work towards, and it’s easier if short-term issues don’t trip you up. Having an emergency fund to help you handle short-term crises can help you to stay on course with your financial plan. Your medium-term investments will open options such as buying property and then you’ll reach your golden years and be able to retire successfully. While there will certainly be ups and downs along the way, it all starts with an emergency fund.
This article has been adapted from a recent piece put out by M&G Investments.