The nitty gritty of emergency funds

By Tania Ngima

A glance at news abroad continues to portray gloomy times ahead for the financial markets. It would be naÔve to assume that the effects of this ‘recession’ as some journals are calling it will leave us unscathed even if it will only mean that our finance houses will put measures in place to avoid situations that may lead to a ‘credit crunch’. This is where an emergency fund or money for a rainy day comes in. However, how easy or how hard is it to put a rainy day fund in place, what are the pitfalls and factors to consider? How does a household survive job loss from one breadwinner or even in unfortunate cases the sole income earner?

How much

How much worth of expenses should your rainy day fund ideally contain? Experts advise from as little as three months all the way to nine months. From your budget, make a list of minimum monthly bills that are not tied to being at work. These could be those such as food, rent or mortgage, fees, utilities and other debt re-payments. Strike out from your total expenses those you can confidently do without; subscriptions, dining out, entertainment, new clothes, club memberships, cable TV, etc. Include expenses which might grow in view of the job hunting process; internet access, phone bills, postage expenses for resumes etc. This amount represents the bare minimum of monthly expenses. To determine the number of months to provide for, every case is different.

Consider the following. What sort of industry do you work in? Are jobs a dime a dozen or harder to come by? Do you have certain unique credentials that would make your job hunting process easier? Keep in mind amidst all this, that if you unexpectedly lose your job, meaning you weren’t already looking while you were in employment, it could take at least 2-3 months minimum in a job strong market. If you have another spouse’s income to hang onto in the meantime and s/he is not likely to be unemployed at the same time as you, you will be able to get by with fewer months worth of expenses. Also, if you have a side income independent of your job that will continue to make you money, you can make the requisite adjustment downward.

Accumulates

In the midst of creating an asset or stock portfolio, investments, retirements and numerous other ventures, where do you get money for your emergency fund? Look at your expenses keenly. Are there some that you can do away with and channel this money instead to your rainy day fund? Say you eat out twice a week. Or you go to the movies every weekend. Reduce these expenses by half and redirect this money to an account that cannot be touched until it accumulates to the required level. Once this amount gets to say, Sh15,000 approach a bank that can allow you to open a purely savings account without charging you ledger fees as long as you don’t go below a certain amount. Of course, this takes discipline but the rewards are worth it. However, if you’re paying debt, especially high interest debt such as credit card, you might want to weigh one against the other in terms of opportunity cost. If your savings account earns you three to four per cent per annum and your credit card interest eight per cent or more, then it makes sense to pay down your debt before setting up a fund. However, if you or your spouse did lose your job you would still need a fund and at the same time pay your debt. For one month, pay off only the minimum balance on your credit card and channel the rest towards an emergency fund, to keep some money aside in case a crisis comes up. Take up your debt the next month and work towards reducing it substantially until it’s over. In the same way, it makes no sense to have substantial emergency funds and still be paying down a high interest debt. Try to achieve the balance, with more emphasis on reducing the debt as it has more negative repercussions.

However, where the trade off is between money that is benefiting from the power of compounding, and paying debt, leave this investment as it is so as not to lose on substantial interest earned.

Bank charges

You don’t want to stash your money in an account where you get charged more on ledger fees or where it will be whittled away more by inflation than the interest you earn. So, keeping with the guiding principal of conservatism, where do you put your funds? Your money needs to be in cash, or assets that can be easily liquidated; within one business day at least. The ideal avenue for this is to put some in a dedicated bank account without charges (and with a 24hr ATM), and then some in high yield savings bonds and lastly, short term Treasury Bills. Insurance may also be considered as part of your strategy, especially insurance that helps offset your risk levels, say health, auto and liability insurance.