If 2020 has taught us anything, it is that life is uncertain.
It has also taught us to never take our homes, jobs, health, or even our currency value for granted again. Each of these uncertainties could land us in a difficult position through cutting our source of income, undermining the value of our savings, or incurring large unexpected expenses.
While twists and turns are inevitable in life, some people are more financially equipped to deal with them than others.
What is an emergency fund?
An emergency fund can be defined by money set aside and made easily accessible for big, unexpected expenses. These expenses could include:
- Unforeseen medical bills
- Home/car repairs or replacements
- Other accidents
Why you should build an emergency fund?
This pool of money acts as a financial buffer for when the unexpected happens. It helps to protect your family and yourself from the impact of financial shocks on your wellbeing. It also buys you time to replenish your finances.
In these situations, it also helps you avoid taking out an extra loan, which is especially important if you are already in debt.
Where should you put your emergency fund?
This is a common mistake when it comes to emergency funds. People focus on the quantity of money they put aside, but not on where to maintain their emergency funds.
You should consider these two factors:
- Liquidity: you want to make sure you can access your funds quickly and easily
- Safety: not just of security, but also of value
However, this is a tough line to walk. For example, you store it in cash form in a safe in your house. It is extremely liquid, but it may not be safe. Your emergency funds are under the risk of theft and inflation.
You want to pick a form and place to store your savings without it losing value (so it has to keep pace with inflation and maintain purchasing power). If possible, you might even want to put your savings to use, so it can grow into more value.
Here are some options for your emergency fund:
As deposit in a high yield savings account
Make sure the interest rate on your deposit would cover for any losses in depreciation and inflation.
As a more stable foreign currency
Other than picking high-yield savings accounts, other creative ways to do this include converting your savings into a more stable currency before letting it sit.
Here are some African currencies that experienced depreciation in 2020:
- The Rand — lost 18% of its value between January and October.
- The Naira — lost ⅕ of its value between March and August.
- The Kenyan Shilling — depreciated by 6.3% between January and July
- The Kwacha — depreciated by 49% between September 2019 and September 2020
Multiple currency wallets and accounts allow you to convert between your local currency and your target storage currency (e.g., USD) when you need it.
The account in foreign currency can also act as a separation between your daily expenses and your savings.
The main thing to consider when embarking on this strategy is the exchange rates offered, and the accessibility of those foreign currencies.
Check out digital multi-currency wallet: Eversend (App Store 4.6 rating | Google Play Store 4.2 rating). Started by African founders, this app is an extremely versatile tool to maximise personal financial management. From the app, you can easily exchange and store your money and emergency fund in a more stable currency.
So how do I start an emergency fund?
Calculate how much you want to have in your fund.
Look into your spending over the past 3 months. Aim to save for at least 3 months of expense, ideally 6 months.
If your household is stable and diversified — i.e., you are part of a two-income household, then 3 months worth of emergency fund might be enough. On the other hand, if you are self-employed or work freelance in a single-income household, you might be better off with a 6 month emergency fund.
As a rule of thumb, a larger sum of money will keep you resilient against a larger financial shock.
This may seem like a lot at first glance. Don’t worry, start even if you don’t have a lot. Having a small emergency fund is better than having no emergency fund.
Set a monthly saving goal.
Take into account how much you make, any debt you have, and how quickly you want to reach your goal.
Check your debt.
If you have debt, pay these off first. Salary loans, overdraft, mortgage, etc.
Audit and slash your spending.
While you are at it, identify excessive spending. This could come from changing suppliers for utilities, eating out less, or stopping subscriptions that you no longer need.
Move money into your emergency fund automatically.
You may have heard of “paying yourself first” as soon as your salary comes in — this includes paying into your emergency fund.
Set clear standards for what constitutes an emergency:
Check the expense against these factors:
- It’s unexpected
- It’s necessary
- It’s urgent
E.g. Apple dropping a new phone is not an emergency.
There you have it! While we can’t guarantee economic stability and rapid recovery for 2021, we can do our best to take financial matters into our hands.