Imagine suddenly losing your job one day or getting into a serious accident. Would you be prepared to deal with it financially?
When life is good, these are things that we don't think about. But these uncertainties can certainly happen anytime. We can plan on how to save for them by putting money into an emergency fund.
What is an emergency fund?
Money set aside for unforeseen financial emergencies such as layoff and sudden illness is an emergency fund. If you have insurance for your medical expenses then that is good. However, what if you are laid off from work.
Typically, an emergency fund is equivalent to 3-6 months of expenses and this should cover everything from daily meals, educational expenses for the kids to loan repayment and phone bills. So, do the math: if you spend an average of $3,000 a month, you should have at least $9,000 to $18,000 in your bank account.
An emergency fund should be liquid and can be withdrawn and used anytime. It's advisable that you keep the fund in an account that allows you to withdraw the money easily, such as a savings account.
Your property isn't your emergency fund, as you still need time to sell your property and probably at a loss if you're desperate for cash. Also, it's not a good idea to keep your emergency fund in a fixed deposit as you cannot withdraw that money anytime. In some cases, you lose the interest you earned or you can even face penalties.
Related: Be Thrifty Now to Thrive in Your 30s
Advantages of having an emergency fund
You can say no to loans. With an emergency fund stashed aside for a raining day, you don't have to become a debtor when you're in urgent need of cash. Loans have exorbitant interest rates and it's not something you want to deal with when times are bad.
This money will be really useful for you and your dependents, if it comes down to that. You don't have to borrow loans or expect handouts from your friends. Something we all know is very painful to do.
You can take a break from corporate life, and go travel for a while or learn a new skill to make a career switch. Your carefully saved emergency fund gives you that kind of independence because you know that you won't be left stranded with no cash for daily expenses.
How can you build up an emergency fund?
While it may be daunting to save for an emergency fund, there are practical steps you can take to set aside money for an emergency:
1. Prioritise Your Expenses
After you set aside money for essentials every month such as food, transport and mortgage payments, you should decide to save a certain amount every month and put that into your fund.
2. Use Budgeting Apps
You can also rely on technology to help you set aside money. There are several budgeting apps ranging from GoodBudget which uses envelopes to categorise expenses, helps you decide how much you'd like to spend for each category and tracks down your expenses. Toshl assists further in planning by analysing earnings as well as spending and Wally allows you to scan receipts, receive notifications when payments are due or when you reach a target for savings.
3. Automate Your Savings
If willpower is an issue, this could be an easier option. You can decide to instead automate the process. Through an automated process such as a GIRO system, you can funnel up to 20% of your monthly salary into a separate bank account.
4. Expand Your Income Sources
If your monthly salary is not enough, for instance, if you earn $2,000 a month, it would be very tough to set aside for an emergency fund after your CPF deduction. There are many ways you can make money on the side that can contribute to your monthly income.
5. Save drastically over a shorter period
There are different ways people save money, depending on one's personality and character. Some prefer to save a little amount here and there over a long time-period, but others can save more if they cut down drastically over a shorter period. If you're the type who can take the more brutal path, you can choose to "blitz." For example, you can opt to live on just 50% of your income over a 1-year period. You can hit your goal of saving up to 6 months of expenses easily and you can afford to relax after your 1-year deprivation period.
6. Funnel your bonuses into your emergency fund
It may be tempting to spend your hard-earned bonus on a big-ticket item such as a grand holiday or a car you've always had your eye on. But this is also the opportunity to save for your emergency fund. So, hold on for just a little more, and funnel your bonuses straight into your emergency fund. Once you've reached your target, you can well afford to splurge a little your next bonus on something you've always desired.
7. Diversify Your Savings
A savings account is a good option to keep your emergency fund in because of its liquidity. If you can, open a high-interest savings account and put your money there. You'll need to fulfil a couple of simple banking actions to earn bonus interest. Alternatively, you can also keep your funds in Singapore Savings Bonds.
The beauty of putting your money in Singapore Savings Bonds is that you can withdraw it anytime, without losing the earned interest. The interest rate works out to around 2.12% per annum over a 10-year period. It's not fantastic, but it's still better than the average interest rate you earn from most savings accounts. You can obtain SSBs from these participating banks: DBS/POSB, OCBC or UOB.
An emergency fund is a must, but how much is inside is up to you
A minimum of 3-6 months' worth of expenses constitutes an emergency fund. If you can afford to put aside more money, then there is nothing stopping you from doing so. You don't have to build your emergency fund all at once. Start small, put aside a part of your income every month into the emergency fund.
Encourage your family members and friends to also build an emergency fund of their own. It is a wise way of saving your income for a rainy day.
This article is first published on BankBazaar.sg.