How to build an emergency fund

Imagine heading home with a box of your office belongings. As you arrive, you recall your boss unapologetically saying, “You’d be a better fit elsewhere.”

You’re still processing the past hour, and as you blankly stare ahead, a pool of water at your front door brings you back to reality.

Not only have you been fired, but your home has just been flooded.

This is a terrible coincidence, and an unlikely situation, but it’s certainly possible. Thousands of South Africans find themselves in precarious financial situations every day. 

How will you be able to survive until you find another job? And how will you pay for the water damage?

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Elize Botha, managing director of Old Mutual Unit Trusts, notes, “Emergencies do not wait until you have cash available, they can happen at any time.”

If you are unprepared, you may have to go into debt to cover your costs, which could create financial strain for several years.

When should you start building an emergency fund?

According to Botha, the need for an emergency fund depends on individual circumstances.

“For a student who lives with their parents and takes a bus to university, it’s less critical than for a person with a home, dependents, and a car that’s financed,” says Botha.

“Personal circumstances dictate the need for an emergency fund. For someone in the latter category, it’s essential to start saving for an emergency as soon as possible,” she says.

According to Kerri Lutz, wealth coach at Women’s Wealth, you should start building an emergency fund as soon as you start earning money.

“Life can be unpredictable. The economy can change, impacting your income, you can lose your job, and even if you are self-employed, some months are easier (or quieter) than others,” says Lutz.

“Having an emergency fund acts as a buffer against unexpected expenses, ranging from the smaller ‘I need a new vacuum cleaner’, to the more devastating ‘I’m not able to work for the next six months’,” she says.

How much should be saved in your emergency fund?

Lutz points out that you should ideally have an emergency fund that can carry you over three to six months.

“The first step is working out your monthly spending. Once established, multiply this number by three or six, creating a financial goal for your cash resource,” says Lutz.

She advises starting with a small goal, such as saving for two weeks’ expenses or R5,000, whichever amount is the greater of the two. Once you’ve achieved this, set yourself a new goal, such as saving for a month’s expenses, and then two months’, and so on.

“As each person has a different budget and expenses, you will need to adapt this model to suit your personal finances. If needs be, you can reduce both the monthly amount and the end goal of the amount saved in your emergency fund,” says Lutz.

“The most important thing is to commit to constantly putting money away into your emergency fund until you reach your financial goal,” she says.  

Where should your emergency fund be kept?

Lutz believes you need to cultivate discipline not to dip into these funds and that, for this reason, it’s best to keep these cash reserves in a high interest-bearing savings account that’s immediately available, but safe from temptation.

“By definition, you need the money because it’s an emergency, so it is best to have immediate access. Therefore, we would not advise a fixed account,” explains Lutz.   

According to Tandisizwe Mahlutshana, spokesperson for PPS Insurance, an emergency fund should be part of your financial plan.  

“Saving for a rainy day, such as needing to buy a new tyre because the spare wheel burst, should be kept in a very liquid account which would make it easy to access when you need it,” says Mahlutshana.

“But be careful, don’t dip into this fund for anything else - discipline is paramount,” he says.

What are the pitfalls of an emergency fund?

Mahlutshana cautions that the idea of an emergency fund can mislead people into thinking that they have put away enough for any emergency.

“Imagine you put R50,000 into an emergency fund, but you don’t take out disability cover because you know you have an emergency fund. How far can that R50,000 get you after getting disabled and you are unable to continue working?”

However, if your emergency fund is part of a comprehensive financial plan, other financial safeguards will come into play. This will mean the emergency fund itself won’t require a large amount of capital.

Allan Gray agrees, and notes further that where you choose to save these funds is of critical importance. Bank accounts, they say, present an untenable risk.

“Over time, inflation erodes the value of your money, meaning that the same amount of rand will buy you less,” says Allan Gray.

“Unfortunately, even if you save consistently, if the money you put away doesn’t grow enough to at least have the same amount of purchasing power at some point in the future, then you are not being rewarded for your discipline and sacrifice, and you are in fact losing money.”

It’s a difficult toss-up between having your money readily available but having its value depreciate over time, or having it grow in value but forfeiting its liquidity. Unit trusts can present a compromise of sorts, as funds are generally available within five working days.