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What is an emergency fund and why do you need one?

When used in the right way, an emergency fund can serve as a buffer against unforeseen expenses and prevent you from turning to high-interest debt.

While other parts of one’s financial portfolio may get more attention, the emergency fund is an often overlooked yet fundamentally vital component of one’s entire financial portfolio.

You either know the immense relief of having an emergency fund in place or the financial stress that results from not having access to emergency cash.

Here, we will take a closer look at why an emergency fund matters, and why you should start saving towards one today.

Understanding an emergency fund

An emergency fund is a stash of readily available cash that you set aside in anticipation of large, unexpected costs that, if left unpaid, might have a devastating impact on your finances.

To avoid having the funds in your emergency fund serve double or even triple duty, they should be set aside specifically for this reason.

For instance, it’s not wise to put aside a large sum of money for unexpected costs and leave it open for holiday expenditures or house improvements. Make a list of sensible purchases to make with this money to avoid the temptation to use it for other purposes.

Why do I need an emergency fund?

A well-stocked emergency fund serves multiple purposes. Your emergency fund can serve as a buffer against financial hardship and prevent you from resorting to high-interest loans provided you save it in the right place.

As you save money for a rainy day, you increase your liquid assets, which will help you out if you ever need to seek financing or credit. By setting aside money regularly, you may practise and instil financial discipline while also gaining the peace of mind that comes from knowing that unexpected bills won’t cause a major financial setback.

Whether you’re a freelancer or contract worker, an emergency fund can serve as a great protection against income fluctuations, with the knowledge that you can still pay your bills even if your earnings take a hit.

Moreover, having an emergency fund can help you avoid tapping into savings and assets that were originally set aside for other purposes and therefore incurring debt to your future self.

How can I use an emergency fund?

You can utilise the money in your emergency fund to cover any unforeseen expenses. An emergency fund is essential in times of economic uncertainty like the present one since it can be used to cover one’s living needs in the case of job loss, retrenchment, reduced work hours, or salary reduction.

Also, it can be used for expensive outlays like deductibles, co-payments, and alternative therapy sessions that aren’t covered by your medical aid or gap insurance.

In the event of a natural disaster, such as a flood or a fire, having access to an emergency fund can be invaluable. It’s important to have access to emergency funds because it can take time for insurance claims to be processed and paid, even if you have short-term insurance to cover such occurrences.

Expensive veterinary care, including x-rays, surgeries, and other procedures, as well as taxes, car repairs, and last-minute trips, may add up quickly.

Unexpected expenses should only be paid for with your emergency fund, but it’s still a good idea to keep track of them when they come up so you can make room in your budget for them in the future.

Where should I save my emergency fund?

You should keep your emergency money in a place where you can get the funds quickly, where they can grow interest, and where you can’t use a debit card.

If you don’t have a bank account, you can use an OTT Voucher to store your funds using cash.

Interest can be earned on fixed deposits and notice accounts, but there may be a penalty if you withdraw the funds before the term is over. However, because withdrawals from a TFSA reduce the amount you can contribute over your lifetime, these accounts are better suited for long-term investments.

Retirement annuities are another type of investment that is best used for long-term savings and are not accessible until the investor reaches the age of 55.

If you have money invested in a discretionary unit trust portfolio for the long term but need some of it now, you might have to take it out at a bad time for the market and end up losing money.

Access bond accounts are a safe location to keep cash in case of an unexpected expense. Although you won’t see any actual money from these donations, you’ll end up paying less in bond interest and having more cash on hand.

Also useful is a separate savings account that is connected to your primary account but cannot be accessed with a debit card. Keep in mind that the value of an emergency fund is not the interest you may make on these saved assets, but rather the cost of pricey short-term debt.

How much money should I put in my emergency fund?

Your own experience, education, and expertise, as well as the field in which you work, will play a role. High-skilled workers in fast-growing fields are less likely to be laid off than those in slow-growing or stagnant fields.

Your monthly living expenses, your short-term insurance and medical aid coverage, the number of children you have, if you have pets, the number of vehicles you possess, the size of your property, and your health state are all additional aspects to think about.

The best course of action is to review one’s monthly budget and decide how much of one’s discretionary income should be set aside in an emergency fund.

Final Thoughts

Having an emergency fund can help you avoid becoming bankrupt in the event of an unexpected emergency. While it may not be enough to eliminate the issue, having access to emergency funds will provide you breathing room and allow you to weigh your options.

Constantly feeling like you’re on the verge of losing everything financially is quite stressful, but a well-stocked emergency fund can put your mind at ease.