Is your emergency fund enough?
The purpose of this fund is to provide you a safety net so that you have enough liquidity to cover unexpected financial needs
IT was 2 a.m. Anthony, a 17-year-old college student, was awakened by a sudden sensation of excruciating abdominal pain. Based on his incessant moans, facial expression and body movements, his parents sensed that the agonizing pain may not be normal stomach cramps. So they decided to rush him to the nearest hospital. Based on the observed symptoms and progression of pain, the attending physician’s diagnosis was an inflamed and impending rupture of the appendix. Finally, the surgeon came and made a final diagnosis and recommendation to perform the appendectomy immediately.
What is the implication of this occurrence to an ordinary household? In addition to the emotional anxiety of having the teenage son go through a medical procedure, the parents had to consider the hospital expenses it will entail. The question that confronts every family is whether they have sufficient financial resources to cover contingencies such as this. Let us take a second to assess your current financial situation now.
Is your emergency fund enough ?
First of all, we need to define what an emergency fund is. An emergency fund is an amount of money which is specifically set aside to respond to unexpected financial emergencies such as an accident, illness, loss of job, natural calamities, sudden death of a family member, or large medical bills not covered by your health insurance.
The purpose of this fund is to provide you a safety net so that you have enough liquidity to cover unexpected financial needs. In this way, it will reduce the need for you to resort to high-interests debt.
If you rely on borrowing as a response to financial emergencies, you will most likely find yourself entangled in a financial rut. Consequently, it would seem like that you cannot get out of the vicious cycle.
How much emergency fund should we build? The rule of thumb that financial planners suggest is setting aside six months equivalent of your normal living expenses. What this means is that you need to assess how much you have been spending for at least the past three months to get the average amount of money you spent every month then multiply it by six.
Another yardstick is how many months it will take you to look for another job based on your qualifications. For example, it takes a year or two for nurses to get a job in a hospital. Therefore, certain occupations may need higher multiple of income as emergency fund.
Once you have determined the target amount, you can take a look at your current resources like savings in the bank and current sources of income. You might want to take into account your current expenses and liabilities. From hereon, you can decide how much to deposit to your emergency-fund account every month. In this way, you will be able to calculate how long it will take you to accumulate your emergency fund.
Where do I keep this fund? Emergency funds should be placed in a highly liquid financial instrument such as a savings account which allows quick access to funds so you can withdraw them anytime. Accessibility of fund is the primary issue here and not the interest rate. So even if the money does not grow beyond our current inflation rate, it is not something we should worry about since the money is earmarked for emergency situations. Your financial planner can help you allocate other resources to higher yielding financial instrument for long-term needs based on your risk tolerance to make up for the minimal yield of your emergency fund. Recently, a bank with a tag line, “We find ways” introduced a new program where money placed in their money market funds which provides a relatively higher rate of return may be transferred to the savings account when needed. This may be a good alternative.
Once your emergency fund is set up and your debts (if any) eliminated, you are now ready to move into investment planning to grow your money. In subsequent issues, we will discuss additional ways to cushion the financial impact of possible family emergencies.
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Arlyn Cheng is a Registered Financial Planner of RFP Philippines. She is a Financial Advisor of a leading insurance company in the Philippines.
Source: http://www.businessmirror.com.ph/index.php/en/business/banking-finance/33896-is-your-emergency-fund-enough
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