Manage My Money is a mini series looking at ways in which to budget and save. In this article we look at investing in an Emergency Fund.
In our previous blog, we looked at the importance of saving and how that can help us achieve our goals and we started to look at investments.
When you decide to start investing, it’s important to acknowledge that there is a risk involved. Investments tend to fluctuate based on many factors such as demand, world trade, exchange rates, inflation etc.
This is why we need to ensure that a safety net is in place – a more secure investment that will remain consistent while you can then look for more growth with your other capital. This ‘Investment net’ is called an emergency fund.
Timeframes and Savings Goals
Most of us have long term savings goals whether it’s going on vacation, buying a new car or getting a new laptop. The time period between now that future goal is often called a timeframe.
To achieve your goal takes a lot of discipline and a budgeting system in order to accumulate the funds.
What happens when something comes up during the savings timeframe and you need cash? Do you have enough funds in your bank account to cover the costs or do you have to dig into your long-term savings?
What is an Emergency Fund?
Emergency funds are usually made up of liquid assets, meaning that they are easily accessible and it’s convenient to withdraw cash.
The amount of funds you should look at holding in an emergency fund is 3-6 months’ worth of living expenses. This amount can be determined by your needs and circumstances.
Some people may need to save more than 6 months’ worth of expenses.
Why should I have an Emergency Fund?
The reason for an emergency fund is to cover your expenses in the event that you lose your income or if you have a sudden large unexpected expense. This fund can help provide a buffer to cover those costs or until you find another job.
Another term for an emergency fund is a ‘Mojo Jar’. Once you have an emergency fund in place you now have some financial protection and can then live life to the fullest – you’ve got your mojo.
The risk with and without and Emergency Fund
Having an emergency fund in place, protects us from having to dig into our long-term funds.
Long term aggressive funds are volatile and even though they offer a good return, there is also a high chance it can lose half of its value at times.
A good example is when COVID hit in 2020 and the market took a major downturn. A lot of people were forced to withdraw from their long-term funds which were not doing well at the time.
If these people had an emergency fund available, they could have withdrawn the funds they needed without touching their long-term investments.
Emergency funds give us the safety of mind knowing that we have extra funds to help us out in the short term without needing to put our long-term goals on hold.
It takes some emotional strain off our mind knowing that we have a backup or plan B should we need to access extra funds during challenging times.
What are the options for opening an Emergency Fund?
There are various ways you can save up an emergency fund to cover you in financially difficult times. We will be going through the basic pros and cons of the different options so you can decide what’s best.
30-day Fixed Term Accounts
A savings account where funds get locked in for 30 days. The pro with fixed term accounts is the secure return. Having to give 30 days’ notice before receiving a withdrawal is the con.
All banks also have a savings account made available to consumers in which they can promise returns around 1.5%. Savings accounts are transactional, meaning you can access the funds at any time. The con, however, is the returns cannot keep up with inflation (Inflation: 4,4% June 2021)
Savings Accounts
Money Market
Interest-bearing accounts offered by banks and asset managers. These are flexible when it comes to transactions. Pros to money markets are they keep up with inflation and the higher the balance, the higher the return. The con is that you usually have to maintain a minimum balance or you be penalised.
This is the old school method keeping cash under your mattress or in a safe (or cookie jar!) at home. The pro to this method is you don’t have to pay any monthly admin fees or transactional fees. Your money is, however, easily accessible to thieves and is not earning any interest. With inflation it’s therefore losing value the longer it’s there.
Under the Mattress
Conservative Unit Trust
These are secure investment portfolios made up of mainly cash and bond assets which are considered quite stable. The idea around a unit trust is that you can target a return depending on your risk appetite (e.g. Inflation + 1%-3%). This factor can also be a disadvantage as you can possibly lose money too if you are not sure what you are doing.
As you can see above there are many ways to save for the short term. All of them have their advantages and disadvantages and are ideal for certain scenarios.
So, which one should you choose if you’re not entirely sure? We think one of the most flexible form of short-term savings is opening up a unit trust.
They offer a good return that’s protected against inflation and you’re able to access the funds within 5 working days. Unit trusts are highly flexible and diverse, allowing any risk preference to benefit.
If you would like to find out more about unit trusts and how to open one, send us a message and we will get in touch.
In the next article we will be explaining what unit trusts are, and how they differ in terms of risk.
FAQ's
- What is an emergency fund?
- Why should I have an emergency fund?
- How can I open up a Unit Trust?
