Thursday, January 14, 2010

Why you need an emergency fund

Question: It seems that everyone is nervous about the financial crisis. And I can't help but get nervous too. I keep reading in the newspapers all the negative effects of the crisis - people losing their jobs, their homes, companies closing down and the prices of goods going up. Although I have a regular job, I don't have much savings. How can I better prepare for the crisis? - Arlene M.

Answer: One thing good about the current global financial crisis is that it has 'woken up' a lot of people who otherwise have had no thought about financial planning. We all need to manage our wealth well and plan for the future. And there is no better time to do so than now when the economy worldwide is either in recession or in a slump. Our country is no exception.

Saving should be a priority for everyone. When we have put away some funds for the future, it gives us a sense of security, knowing that we can rely on something should any unexpected event occur.

Financial experts have long been advising people to start an emergency fund, and we advise the same. An emergency fund is a money pot that equals three to six months' worth of your living expenses.

Reasons for having an emergency fund
Every person should try to have an emergency fund tucked away. Here are the reasons why:

1. To have a fund to dip into when unexpected events occur. When you lose a job unexpectedly, it may take awhile until you get another job. Having an emergency fund will tide you and your family over until you get a regular paycheck again. The same thing can be done if someone in the family gets sick and racks up a huge medical bill, or unexpected expenses have to be met, such as house or car repairs.

2. To reduce reliance on credit. Relying on credit cards or personal loans from banks to pay unexpected bills due to emergencies can be very costly. The cost of borrowing - also called interest - can be as much as 36 percent or more a year. If you have an emergency fund, you won't need to assume any further burden in the form of interest expense since you will have ready funds at your disposal.

3. To be financially stable. Having an emergency fund will keep you in charge during times of crisis. You won't need to worry about meeting the day-to-day expenses while paying for your emergency costs. And you won't have to miss paying your regular bills either. And even if the economy is not doing great, you will be safe. An emergency fund will thus be for your and your family's peace of mind.

What to do
You mentioned that you don't have much savings. If the amount you have saved so far is not yet enough to cover three to six months' worth of your living expenses, make it a priority to reach this goal.

Start by committing to save every payday. Take a regular amount out of your paycheck as soon as you receive it (say 10 to 20 percent) and before you spend it otherwise. Go over your expenses'you may be able to give up an unnecessary expense to increase your deposit for your emergency fund.

Put this amount in a savings account which is different from your payroll or checking account. As you deposit regularly to this account over the next few months and years, you will see this amount grow to reach your emergency fund goal.

Once you have enough money in your savings account, transfer the money in a higher-yielding account such as a time deposit or fixed income mutual fund or unit investment trust fund. Such investments will enable you to potentially earn more interest while exposing you to a low risk. With your money earning, you will be able to grow your emergency fund more without putting extra hours in your work.

One important thing to remember is to put your emergency fund in liquid investments. That means you should be able to get the money quickly when emergencies happen. Don't invest your emergency fund in things such as real estate or jewelry or fine art as it may be difficult to convert this to cash urgently.

Also, don't put your emergency fund in a highly volatile investment such as equities, either by direct investment through a stock broker or through an equity mutual fund or equity unit investment trust fund. Keep the emergency fund accessible and stable as much as you can.

In the US, a lot of people have been laid off or have lost their homes as a result of the financial crisis. Those who have taken the time to build an emergency fund are able to continue on with their lives while they are looking for work and picking up the pieces. Those who weren't able to do so are still in for a rough ride, living on welfare and scrimping as credit has also become tight.

Let's not wait for the worst to happen before we start an emergency fund.

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