In recent times, attention has turned to emergency savings funds and the importance of building them. But there is still some confusion about what exactly an emergency savings fund is and what it should be used for. On this day when we celebrate mothers, who are often the financial managers of Jamaican households, we’ll attempt to answer some of the questions about emergency savings that will put you firmly on the path to financial empowerment.
Why is an emergency savings fund (ESF) necessary?
The term “emergency savings” is exactly what its name implies: funds that are used in an emergency. Concretely, these are the savings that would have gone to people who suddenly lost their jobs at the start of the new coronavirus pandemic. It’s savings that provide a cushion when the unexpected happens, so you don’t immediately start using a credit card or borrowing from people and therefore racking up expenses when life throws a curve ball at you.
Is it different from regular savings?
An ESF is absolutely separate and apart from an ordinary savings account. Both are savings funds that help you plan for the future, but their use is different. An ESF is used to offset high expenses that arise from an unforeseen situation that can potentially deal a devastating blow to your lifestyle if you are not prepared. On the other hand, a savings account, while also a rainy day fund, is meant to cut down on expenses that aren’t upsetting. For example, a savings account would be used to replace your stove. It wouldn’t require you to touch your emergency fund, because it’s not life or death.
When should I use it?
These funds are not only intended to be used in the event of a sudden job loss or drop in income; they also save for other unpredictable incidentals like major emergency work on your home (like roof repairs), and even scheduled periodic expenses (like back-to-school, license, and school fees). annual car insurance, property and income taxes) that can often sneak up on you. Or, depending on your social background, let’s say the beloved pet that you and your children consider part of the family needs surgery to save its life.
It’s not for non-essential expenses, so, no, you absolutely can’t take money out of it because your favorite retailer is having a sale, or to take a vacation, or to fund an emergency friend or family member. It should also not be used as a nest egg for retirement, furthering an education, buying a car or upgrading your phone. If the thing you plan to spend your ESF on is not an emergency, you should NOT use these funds.
How much should be in it?
Of course, there are no hard and fast rules; it depends on your life circumstances and how much you earn. In the past, the rule of thumb was to set aside three to six months worth of expenses. Now, after the reality of the ongoing pandemic, financial advisers are more inclined to say a year, especially if children or a partner are involved. Note that this is not a year’s salary; these are essential expenses. So what are your essential monthly expenses? Rent, mortgage and maintenance, utilities, groceries, gas, loan repayment, medication. Calculate these costs then multiply them by three, six or 12, to see what your ESF should vaguely look like. Also, if you’re in a multiple-income living situation, figure out how much each person can comfortably contribute and factor that into your monthly budget.
Should an ESF be all cash?
Ideally, cash is preferable. But this can also be extended to liquid assets. So if you have assets that can be quickly exchanged for cash, that can work as well.
Where should I put my emergency savings?
Whatever you do, don’t keep this crate in a drawer or closet at home! You want it close at hand, but not so close that you can easily dive into it. Plus, you want those savings to accumulate and earn interest in the meantime. It is best to place it in a high-yield savings account taken out specifically for emergencies. A money market account is also a good place to put these funds, as these accounts tend to give higher returns over time than a savings account, although they can be slightly riskier. Another place to put these savings is in Certificates of Deposit (CDs). This one is a little tricky because CDs are essentially illiquid, which means the funds are locked in a fixed amount of time, and withdrawing them before the time can penalize you. The interest rate on CDs can be attractive, but holding cash in them can come at a significant opportunity cost.
At the end of the line
Start building an emergency savings fund now, if you haven’t already. And if you already have one but put ad hoc funds into it, or if you do it for random, non-essential expenses, start rebuilding it by including payments as part of your monthly budget. As with financial decisions you are unsure of, consult a financial advisor.
Remember that the money you save today can go a long way toward meeting your family’s financial needs when the next emergency strikes.
Lamar Harris, Vice President, Wealth Management, NCB Capital Markets