Emergency Fund Is A Must
The only thing certain in life is that the future is uncertain. As we pursue our goals, fortuitous events may occur. These events can put a major strain on our finances. They can become tough obstacles to our quest for a better tomorrow. Therefore, it is a must that we prepare well for the future. One example of good preparation is by building an emergency fund. This fund, as its name suggests, is meant to address unexpected expenses. Some examples of unexpected expenses are those you incur with a sudden loss of job, change in job conditions, unfavorable health developments, accidents and damages in assets. An emergency fund can help shield us from obtaining cumbersome debt or selling our valuable assets. Building an emergency fund can’t be done overnight. It is a process that requires discipline.
Before we know where we want to go, we should know first where we are now. Hence, the first step is to be able to understand and address our current financial situation. A company’s financial performance is viewed through financial statements related to profitability and liquidity. The same concept can be applied to people. The personal cash-flow statement is an example that assesses a person’s financial situation.
Personal net cash flow is the difference between personal inflows and personal outflows. Personal inflows include your salary, profit from business and income from investments. Personal outflows include nondiscretionary and discretionary expenses. Nondiscretionary expenses are expenses related to the purchase of basic items like food, clothing and shelter. Discretionary expenses are those that have a great chance of either being minimized or avoided. By listing down all of our inflows and outflows, we get an idea of our personal profitability condition, and we also get a chance to improve it.
Another personal financial tool we can use is the personal balance sheet. This will compare our assets and liabilities. Liquidity gaps arise if the current liabilities are greater than the current assets. The knowledge of our profitability condition and liquidity condition will then help us in planning better for our future actions.
Once the financial situation has been determined, and its comparison with the bigger life financial goal has been identified, the next step is to determine a practical goal for the emergency fund. There are various recommendations on how much the emergency should be. Maybe, an emergency fund that is worth around six to 12 months of the monthly lifestyle expenses can be applied. Living within one’s means helps optimize the monthly lifestyle expenses. This recommended period can be enough to manage the tide, especially in case of sudden job loss, to give the one enough time to either look for new work or explore other income opportunities. If one is the sole breadwinner in the family, the emergency fund will have to take into account the total monthly family lifestyle expenses for it to be ample.
Where should we put the emergency fund? There are many options. However, the decision should be primarily based on easy access and liquidity. It will be very difficult to fund an emergency concern using a nonliquid asset like a real-estate property, given the time and effort needed to convert it to cash. Ideally, the emergency fund must be maintained separately from the monthly lifestyle-expenses fund. One option would be to place in bank deposits. Regular savings accounts and special savings accounts are popular choices. Another option is to place the emergency fund in investments that can be easily redeemed.
Should we put most of our money in the emergency fund? No. We have monthly lifestyle expenses, and the emergency fund is not meant for these items. We might miss out on other good investment opportunities that can allow us to potentially beat inflation over time and give us greater wealth in the future through higher purchasing power. Still, the emergency fund is a crucial step we need to take in our quest for financial freedom, since having it will give us a buffer to support the pursuit of our life goals.
Gemmy Lontoc is a registered financial planner of RFP Philippines. To learn more about personal financial planning, attend the 68th RFP program this March 2018. To inquire, e-mail email@example.com or text <name><e-mail> <RFP> at 0917-9689774.
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