If you follow my articles, podcasts or videos, you will know that I talk a lot about emergency funds. The concept of an emergency fund was really drummed into me when I edited Dave Ramsey’s Total Money Makeover for South African readers. I always say that you cannot get out of debt until you have an emergency fund because it is that fund that stops you from going back into debt.
But the thing that has struck me the most is the peace of mind it provides. Think about it: when the Covid-19 crisis hit and our country went into lockdown, how would you have felt if you had three months of your expenses sitting in an emergency fund?
But even in normal times, you may have an unexpected medical procedure and must fork out a co-payment or have a bumper bashing that requires paying a R5 000 excess. Just knowing you have that money put aside will make you sleep a lot better at night.
In my case, I was so motivated by Total Money Makeover that I used my editing fee to boost my emergency fund. Although it did take a while, I eventually built up my full emergency fund, so when lockdown happened, I knew I could survive three to four months of no income. That made life as a freelancer a whole lot more comfortable!
Build your emergency fund before paying debt
This may sound counter-intuitive, but having at least R15 000 – R20 000 in an emergency fund should be a bigger priority than paying off your debt right now. Only once you have that R15 000 safety net in place should you focus on paying off those debts. Once you have that as a starting point, allocate some of your tax rebates, bonuses, or extra cash from a side hustle to build it up until you have at least three months of your expenses covered.
And remember, if you ever need to dip into your emergency fund, make it a priority to top it back up before you spend or save anywhere else.
Where to stash that emergency cash
An emergency fund needs to be readily available, but it also needs to be one step away from your bank account, so you are not tempted to spend it. As this is money you will need unexpectedly, you should not use it to invest for the long term but it should be in an interest-bearing account that guarantees the capital.
Look at the options available at your bank, such as an investment account that pays a reasonable rate of interest and has no fees. An example would be a 32-day notice account.
While you are building up that emergency fund, also consider starting a separate contingency fund. This is different from an emergency fund as it is for planned future expenses – things that you know you will have to pay in the year ahead.
This could be a major car service, a family holiday or next year’s school fees. A contribution to a contingency fund should form part of your monthly spending budget and be funded each month as part of your living expenses.
You could use similar bank products for your contingency fund, but rather keep the two accounts separate, even if combining them gives you a slightly better interest rate. These are two different goals, with two different objectives and you don’t want to be using emergency funds to pay for school fees or holidays.
This post was sponsored by Nedbank.