A well-constructed financial plan should ideally always include an emergency fund, the purpose of which is to cover short-term budget shortfalls and the COVID-19 pandemic has highlighted just how important it is to have such a fund.
Many individuals and families are unfortunately going to struggle to make ends meet over the coming months. They may earn less income than usual, or even no income at all, due to the inability to work during the lockdown. Those fortunate enough to have created an emergency fund will hopefully be able to cope slightly better than those without such a fund.
An emergency fund is simply a bank savings account, a money market account or a similar type of investment with sufficient money to cover between three and six months of your living expenses set aside for unforeseen circumstances. The fund is there to ensure that you do not have to borrow money or access your long-term investments in the event of a situation which results in a total or partial loss of income, job loss, medical expenses not covered by your medical aid and unexpected repairs to your car/home and other unforeseen expenses.
If you do not already have an emergency fund, you should consider starting one now by saving some money on a monthly basis over and above what you already save towards your other long-term investments. When choosing a bank account in which to invest these funds, you should consider the following criteria: (i) you must be able to access the funds in the event of an emergency; (ii) you should avoid bank accounts with monthly service fees as these might drain your account instead of working for you; (iii) you must ideally be able to add to the account on a regular basis as and when you have available funds; (iv) you should not be tempted to use the funds to cover ordinary living expenses.
Once you have built up an appropriate emergency fund, you should then re-channel the amounts you were saving towards paying off debt or adding to your other investments.
Your emergency fund and your medium-and-long-term investments both form essential components of a well-constructed financial plan. The emphasis of an emergency fund is to ensure immediate access to funds, so accessibility to your money in this instance is more important than earning the best available interest rate, while the goal of your medium-and-long-term investment plan is to grow your capital at a rate that is greater than inflation over time.
Having an emergency fund will provide you with peace of mind and the knowledge that you and your family will be better equipped to cope financially when times are tough. Who knows when we will next experience something like a COVID-19 pandemic? An experienced Certified Financial Planner will be able to assist you to develop a financial plan that takes your short, medium and long term needs into consideration.
Rands and Sense is a monthly column, written by
Ross Marriner, a CERTIFIED FINANCIAL PLANNER® with PSG Wealth.
His Financial Planning Office number is 046 622 2891