As people we tend to function with the notion that any unforeseen circumstance “will not happen to me” never considering that if it should happening to you, what mitigating resolutions do you have? Aside from getting the necessary insurance policies to mitigate risk, how do you plan financially for unforeseen circumstances? How do you ensure that any unforeseen situation does not hamper your financial situation or lead you into debt? Our advice at SimWealth is “Pay Your Self First” by building an emergency fund.
An emergency fund is an account for funds set aside in case of the event of a personal financial dilemma, such as the loss of a job, severe illness, or a major repair to any high purchase asset. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to draw from high-interest debt options, such as credit cards or unsecured loans. (Investopedia, 2019)
This is especially important for first time workers and young professionals. Traditionally an individual who just got their first job and wants to start amassing assets typically takes out credit facilities, our advice is you should avoid this by all means necessary by firstly building an emergency fund.
When building an emergency fund, you typically want to have income that covers your living expenses for a period of 3 – 6 months. It is therefore important to firstly create a budget where you identify all your monthly fixed expenses, and consider other variable expenses that you would consider important.
Once those expenses have been established, the next step is to cut down all your bad debts, this typically includes all your credit facilities such as credit cards, personal loans and unsecured loans. By eliminating these you cut down all the high interest facilities that work against you and reduce your disposable income.
Once bad debts have been eliminated, your disposable income increases and you can start allocating the funds that have been “freed up” towards your emergency fund. It is also worth remembering before building any savings, wealth or investment portfolio that you firstly to built an emergency fund.
When building the emergency fund we advise that you allocate 20% of your monthly disposable income until you have reached an amount equivalent to 3 – 6 months of your total expenses. Always bear in mind that an emergency fund is not a wealth building investment strategy, therefore it needs to be placed in a very liquid financial asset, one which you can access the funds within 48 hours.
The advantage of building of an emergency fund is that it ensures you secure your financial position without getting yourself into debt, it also ensures that should a “it will never happen to me” moment occur you are in a comfortable position financially to deal with it.