An Emergency Fund = Your Financial Lifeline

Hi Reader

Welcome to The Money Series and if you are new here, thank you for signing up. Personal Finance can feel ambiguous and overwhelming, but I am here to help simplify the journey.

Let’s get a bit vulnerable here. At the height of the pandemic in 2020, during a routine check-up, I received a diagnosis that required surgery within 12 days. I went from being a healthy, happy girl preparing for her CFA exams to preparing for surgery. This sudden change forced me to pull the brakes on work and life to focus on my health and recovery.

What I am driving at is that life can throw curveballs that can alter our normal routines. These curveballs can differ for everyone – a faulty car, unplanned medical expenses, or even the COVID-19 pandemic. That’s why today, we will explore setting up and maintaining an emergency fund for the ‘rainy’ days.

How to determine the size of your emergency fund

The first step in setting up an emergency fund is determining your financial baseline – your monthly recurring expenses – which I discussed last week. Experts recommend having at least 3 - 6 months’ worth of your financial baseline in your emergency funds. However, you should consider your peculiar situation in deciding whether to raise yours to about 12 months’ worth of spending.

Consider having a higher-than-average emergency fund balance if:

• You work in an unstable job or industry or freelance with unpredictable income

• You have a health condition requiring regular out-of-pocket expenses

• You have quite several dependants

• You live in a High Cost of Living Country

On the flip side, you can consider having a fund with less than 6 months of your monthly baseline if:

• You have a sufficient safety net in your support system

• You have a very stable job (such as a University professor)

• You do not have dependants

How to Save for Your Emergency Fund

Let’s assume that you currently do not have a designated emergency fund and outline how you can build it over time. The chart below shows the length of time in months it will take to achieve 6 times your financial baseline based on the proportion of your income that you save monthly. For instance, if you save 10% of your monthly income in your Emergency Fund, it will take about 39 months to reach your target as opposed to 7 months if you save 50% of your monthly income. This computation assumes that your financial baseline is about 60% of your income and an annual interest rate of 5%.

One effective method is to automate funds transfer to your Emergency Fund account from your income account. If you receive unexpected income such as bonuses, cash gifts, or inheritance, you should consider boosting your emergency fund with some or all of it. Another good strategy is to sell items you no longer need and allocate the income from the sale to your emergency fund.

Where to Keep Your Emergency Fund

Your emergency fund should be accessible and liquid to allow easy access during emergencies. Two primary low-risk saving destinations are High-Yield Savings Accounts (HYSA) and Money Market funds. These options provide some earnings on your funds while ensuring accessibility. You do not want to keep emergency savings in a risky investment vehicle (such as Equity funds) or stock market investments due to lack of liquidity, volatility, and high risk of capital loss. Note that some money market funds may have restrictions on immediate withdrawal due to the T+1 settlement. In this case, you can use a credit card to cover the expenses temporarily, taking advantage of the interest-free period offered by most credit card providers until you can withdraw from the money market fund.

Next steps

Setting up your emergency fund is not a one-time task. Based on your objective for the fund (as defined by what constitutes an emergency for you), withdrawals will be made to cover emergencies over time. After each withdrawal, you need to replenish your emergency fund, and this can be done at your own pace using the same computations mentioned earlier. Also, regularly review your financial goals and adjust your emergency fund as your situation changes (marriage, relocation, kids, etc).

Remember, having an emergency fund is like wearing a raincoat during a heavy downpour.

Questions or comments? Just reply to this email!

Act Now:

• Determine the multiple of your financial baseline that would be sufficient as Emergency Savings

• Set up an HYSA or Money Market fund

Reflect on This:

• What major outflow did you have in the last 12 months that affected your financial goals?

Till next week, I am rooting for you, money-ly!

Dee

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Disclaimer: This does not constitute financial advice. Please conduct your research or consult your financial advisor for important financial advice.