Preparing for the unexpected
It is impossible to expect the unexpected, because when you are expecting something it fails to be unexpected and something else you weren’t expecting still manages to trip you up. So rather than trying to second guess life, stop expecting the unexpected and simply put a contingency plan in place for when you are next thrown a curve ball. In this way you’re prepared for the worst, rather than sitting around in a state of dread, waiting for it to happen.
An emergency savings fund is the best way to prepare yourself for the dramas, expenses and surprises which are life. Even if you’re thinking your life isn’t that dramatic, your job is secure and you don’t need an emergency fund, here are five real reasons why you do.
1 – The best things in life are free
And the worst things in life are very expensive – losing your job, being injured, having a car accident or having to care for a sick child. However, whether you don’t have income protection, the situation doesn’t qualify or seems too insignificant to claim for, several thousand dollars in an emergency fund can come to the rescue.
At the same time, emergencies are not always related to losing time at work. You may have a tyre blowout and have to spend several hundred dollars to replace that tyre. Or you may experience a rise in your cost of living if interest rates go up and your mortgage repayments go up – that certainly isn’t something you can claim on your income protection insurance but it can pose a real emergency for your budget.
Expenses and disasters can crop up at anytime and happen to everyone. Emergency expenses are a part of everyone’s lives, to different degrees and being prepared for the worst allows you to enjoy the best.
[Kevin] How much should you put in the emergency fund? Three months of basic expenses? Six months? I also agree that some money should be kept in highly liquid cash, and beyond that point one should also look at paying down debt or investing.
2 – You’re more likely to accumulate debt without one
Debt in itself can be an emergency, and commitments to mounting credit card balances and numerous personal loans are stopping you being financially free and secure. As a result, you want to do everything you can to avoid getting into more debt than you can afford, however, it is proven that those people who don’t have an emergency fund are more likely to accumulate debt.
This is because you don’t have the financial safety net behind you and you don’t have the savings and financially responsible skills you need to be able to plan for an emergency and avert the potentially disastrous effects of an unexpected expense. If being able to avoid more bad debt was as simple as setting up a savings plan, what is stopping you?
You think you can’t afford to spare the funds. This is the most common reason people put off building an emergency fund but the truth is that the times you think you can’t afford an emergency savings account are the times you can’t afford not to have one. Think about it, if you’re struggling now, how will you be able to deal with an unexpected expense?
This is where you would normally turn to your credit card to ease the immediate pressure, but this too simply sets you up for another emergency expense down the track as the interest on your card compounds and your monthly payment needs to be made.
[Kevin] This is perhaps true. One has to consider the opportunity costs of not investing or paying down debt as well, but the safer route is also the route with less variance and more security. For some people, an emergency fund means the difference between feeling secure and being able to sleep at night, and worrying about whether one is prepared for what may come ahead. This will play a big part in determining what amount is right for you.
3 – Encourages other good habits
Having an emergency fund can make your more financially responsible in other aspects of your life. In order to save you have to reduce your debts and curb your spending on luxury items to free up funds in your budget to be deposited into savings.
As a result, you’re not only prepared for the worst if it happens, you are also sticking to a budget, controlling your debt levels and living within your means and spending less than you earn is an important lesson for everyone to master.
[Kevin] I like this point. It takes a bit of discipline and practice to start saving up an emergency fund, and this will help to instill good habits which will help you down the road and help you to make good decisions, such as when deciding whether it’s a good idea to cosign a loan.
4 – You could be more at risk than your neighbour
The amount you need in your emergency savings account can also be cause for emergency if you are relying on savings which are not substantial enough to see you through. Most financial experts suggest that you need enough money to cover all of your living expenses for between three and six months. So how do you know you’ve got the right amount?
The answer comes down to your individual situation, not how much your sister, neighbor or co-worker has saved. For example, if you have a career in an industry which is going to see an ongoing demand, and you have strong job security, covering three months’ of expenses may be enough for you. However, if you are in a more demanding career, in a managerial or executive position, or you and your partner both work at the same company, you may need enough to cover expenses for nine months to a year.
Saving such an amount can seem like a daunting task, however, preparation and planning are the most important things when it comes to outlasting tough financial times, and achieving financial security.
[Kevin] Agreed; the more variable the income, the more buffer is needed. Reducing expenses and maintaining a healthy gap between income and expenses also helps a lot.
5 – Your investments and assets are not savings
If you think you can rely on your investments and assets to cover the costs in an emergency you may need to think twice. Investments can be risky and if you put store in the belief that your investments can cover your emergencies, you may not have as much money as you thought. Plus investments can’t always be easily accessed, for example an investment property is not readily turned into cash if you’re out of work and shares and term deposits can charge significant fees for early access.
While you’re considering the assets which can see you through tough times, consider what liquidating those assets really means. It is a short term solution to a longer term problem, and what does it really achieve to sell the house in order to pay the mortgage?
Instead have your savings in an online high interest savings account. In this way your cash can earn interest, you can easily make deposits, but you don’t have access through an ATM or credit card. Your cash remains at call in your account and will at most take two or three days to access as it is transferred to your transaction account. If you want to be covered for every eventuality, you may even consider keeping the bulk of your emergency fund in your online savings account, and a few hundred dollars stashed at home for immediate access.
[Kevin] I think that Alban makes a great point regarding the fallibility of relying on investments as a replacement for highly liquid cash or cash equivalents. One should have a spread of investments across different asset classes and different levels of liquidity. Just as you shouldn’t put all of your eggs in one basket, nor all of your money in a single stock, I think it’s a good idea to have some investments in a retirement savings plan, some in a tax-free savings account, and some in unregistered accounts. One should also have cash at home and at the bank, and ideally one would also have equity in their home, if they own a home.
In addition to cash at home and in the bank as part of one’s emergency fund, I also believe that precious metals have a role to play in one’s overall portfolio, not only as stored in easily-liquidated online accounts (whether secured certificates or unsecured pool accounts), but also as physical bullion. While bullion is less liquid than cash and pool accounts and comes with higher transaction costs, bullion can also add additional diversification and insurance to one’s portfolio.