What is an emergency?
If there is anything that the pandemic taught us, especially when the lockdown happened and jobs were lost is the need to have an emergency fund, the necessity to have some funds stashed somewhere that can caution you in times of need, or calamities, or in this very particular situation, in times of a pandemic, hence our article today, we want to distinguish between an emergency fund and saving fund, explain what an emergency fund is and what it is not,
So get yourself some minutes and enjoy some learning.
According to investor vanguard, an emergency fund is a stash of money set aside to cover the financial surprises life throws your way.
It is from this basis that we want to address this very important topic, but for us to do so let us start by being very clear on what we do not consider to be a financial surprise and hence is not covered by the emergency fund then we will go ahead and say what this emergency fund should cover in as much we are discussing this topic.
A medical bill is not an emergency financial surprise, this is covered under the medical cover insurance, a car breakdown is not under the financial surprise this should be covered by the comprehensive motor insurance, a house burglary or house burning is not covered by the financial surprise, this should be covered by the home insurance cover. With this what we are trying to say is that get insurance cover for anything that you own, and that if you lost or if it got destroyed would cause you financial stress in your normal day to day budget, or that if you’re required to pay for it without prior warning would cause your financial planning for that month to be strained.
Now having said what we don’t consider to be a financial surprise, it is time to explain what we consider as a financial surprise and that is covered by the emergency fund account.
Loss of your primary source of income without your plan or with your plan but you don’t yet have another one waiting and or maybe you are branching into entrepreneurship is what is covered by the emergency fund, nothing else, it is that plain and simple.
And with that understanding, it is time to understand how to measure the value of your emergency fund.
So, for you to determine how much your emergency fund is, it is as simple as:
- i) Determine how much your basic monthly bill cost (this is personal for each individual, but for examples’ sake we will list, food, shelter, utilities, transport, as just a sample, but now go ahead and customize this with the bills that without, your day-to-day life wouldn’t be possible)
- ii) Determine how much your secondary monthly bill cost (in this category you want to consider things that compliment your basic life, like maybe cable, internet (if this is not already under basic hahaha) manicure and pedicure treatment, etc. generally what you want to consider is anything that compliments your life to run smoothly, so be real and list everything with its respective cost, but remember this is a bill that you pay on monthly basis)
iii) Determine how much your tertiary monthly bill cost (in this category you want to capture mostly the social bills, those things that you do as a lift me up or self-care routines so this could be a weekend getaway, an evening catch up with pals, a spa treatment (the key distinction between the tertiary bill and the secondary bill is that this is not a monthly bill and again this might a little bit of an expensive bill)
After listing the above in that order and getting the total amount for each category, the next step is to multiply the categories I & ii by 6 (this is to cater for 6 months) in this case we are doing a beginners emergency fund, then with our category (iii) we want to assume that in these 6 months we will apply our category (iii) account 3 times so multiply the total amount by 3, and then now sum up the three categories’ totals and that is the total amount of your emergency fund.
Remember we’ve said this is a beginners account, hence the assumption here is that if you lose your primary source of income, you have six months of caution funds and hence you have six months to figure out where your next primary source of income will come from without your normal life operations changing a thing, you continue living as nothing has happened.
What this emergency fund is supposed to ensure is that you’re not financially stressed and hence you can focus on getting your footing on figuring out your next source of primary income, it is not supposed to be a long-time lifeline, it is a CAUTION AMOUNT.
Now if you’re not a beginner or if you’re looking into the transition from employment to entrepreneurship or to be a business person then your emergency fund should be for between 24 to 36 months because you will need as much time and peace to focus on your new path, that life bills should not be part of the stress plate.
Now the only part that emergency funds and savings marry is that they both have an estimated amount as target and they both need to be housed in an inflation rate fluctuation proof home. What this means is that wherever you choose to keep these funds must have an interest rate that is higher than the current inflation rate of your region.
The major difference between the two is that for saving, this can be the target is to buy a car, own a home, go for a holiday, or whatever you are saving towards and hence the amount is targeted for a period of time which is known, like maybe your scenario is, “I want to buy a car in 6 months” hence you determine the cost of the car then divide that by the period and determine how much you need per the saving intervals, this means you can have this funds even in a fixed account for that particular period, this can’t be the case with the emergency fund, because take a scenario where your emergency funds are in a one year fixed account and two months after you lock them there you lose your primary source of income, will the funds come in handy? NO, and if you eventually succeed in getting them the cost will be high, which bits the point of having the fund, hence with an emergency fund you want to house in a house where they are accessible in at most 48 hours, and that the recall cost is very minimal if not none.
It is our hope that now it is clear how to establish an emergency fund, the similarities between an emergency fund and savings fund, and the differences as well, if you have any further questions go ahead and ask on the comment box below and we will for sure address them, remember we are happy when you engage us, also if you have a topic, you would like us to feature here share it with us and we will do the dutiful.
Cheers to a great month ahead and let’s wrap up this year in style.