Good morning everyone! This article is contributed by Saving & Happy. For greater detail on this topic please visit the website at www.savingandhappy.com or http://savingandhappy.com/2015/08/the-importance-of-an-emergency-fund/.
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About the writer:
I am a 24-year-old professional living in South Africa. Having recently started my journey towards living debt-free, I would like to share some of the mistakes I’ve made and the lessons I have learned about living in debt. My blog includes discussions around changes of mindset towards savings, budgeting and the basics of investing. Twitter handle: @savingandhapp
Don’t underestimate the power of an emergency fund
An emergency fund is your best friend if you are trying to get out of debt or to generally have the ability to better handle unexpected expenses. This article sets out the basics of such a fund and the reason it is essential that you set one up and maintain it.
An emergency fund is essentially one in which you park aside money solely for the purpose of dealing with unexpected expenses.
We all have unexpected expenses that will pop-up every once in a while (much to your surprise). Recently my 3-month-old puppy was hit by a car while going for a walk. My girlfriend and I needed to rush him to the vet on a Saturday afternoon, which attracted after hour consultation fees. He has recovered well and was very lucky. The total costs for this visit was R2 000 (+-$200) and if I didn’t have my emergency fund in place, my already tight budget would have been destroyed and I would need to play catch-up for the coming months to get my finances in order.
I have been aggressively paying down my debts since February 2015 and the last thing I want to do when I have an unexpected expense is to use my savings I have been building up.
The emergency fund is essentially a barrier between the outside, debt-filled world and your investments. It acts like a buffer of sorts. Your journey to financial independence will be a long one, which requires a lot of determination and planning. Along this path to financial independence there will be various emergencies that will require varying amounts of money, such as a trip to the vet, a flat tire or even a trip across country to help family. Drawing down from your investments in order to deal with emergency expenses will only delay your achievement of financial independence. However, having a strong emergency fund in place will allow you to dodge financial challenges with a lot more ease than those who haven’t prepared for these expenses.
How does this fund work?
There is no rule regarding the size of your emergency fund, but it is good to have between 3-6 months’ living expenses set aside in your emergency fund to enable you to deal with all types of unexpected expenses. Saving up this amount of money will take some time, but remain focused and you will soon have a sizeable savings.
Ensure that your emergency fund is also easily accessible. A fixed deposit with your bank is a good way to store your money in this regard because there will be no delay in you drawing down the money when you need it. It is also for this reason that it is not a good idea to draw down from your investments, as these usually take at least 7 days to get the money out. Not only will this delay you in the short term, but it will also weaken your investments, which delay your arrival at financial independence. Should you not draw down from your investments, you may also be forced to apply for a temporary (short term loan). There may be a delay in getting this loan approved and it is also highly likely that you will have to pay interest back to the bank. Interest is good when your money earns it, but it is not good when your debt accrues interest and should be avoided at all costs.
This article doesn’t intend to set out great detail surrounding an emergency fund, but I just want to point out that unexpected expenses are a way of life – surely it makes sense to make provision for this? An emergency fund is especially helpful when you begin your journey towards financial independence because it is essential that you protect your long-term investments as much as possible while they are being built up. Having a strong emergency fund in place will also considerably reduce the stress that comes along with those expenses you didn’t see coming.