Whenever we talk about finances, usually people will talk about savings, investments, spendings and debt. Rarely will you hear anyone mention building up an emergency fund – with good reason. Emergency fund is not as “sexy” as something like 40% gains on Bitcoin (followed by a 70% drop har har har). Jokes aside, building up your emergency funds should be one of the first things you look into on your path towards financial literacy.
When I first picked up “Rich Dad, Poor Dad” and it blew my mind somewhat, all I could think of was, “How do I invest!?” This led to buying more and more books (some still untouched, to the dismay of my wife). But what these books about investing usually say is the typical “don’t invest more than you’re willing to lose” which, mind you, is solid advice. But here I was, graduated a while ago, clawing right into my savings to survive and desperate for employment. I’m not willing to lose anything and yet I want to… no, need to “make my money work for me”! These guru books never taught me the most basic thing: I needed to build a foundation.
Building your foundation
Come, imagine a little with me for a bit: think of the grandest and most spectacular house that you can dream of. Got that in mind? Now, this house is yours! Think of what you can do with it: ballroom dances, games, slumber parties! “This is the pinnacle of my life!” you think to yourself. Then one day, as wonky weather do, monsoon rain comes pouring down for days leading to weeks. And everyday, you get a sinking feeling; literally. Your house is sinking! Apparently your grandiose abode had some shortcuts taken during construction – they skimped on piling and building the foundation! What would you do in that situation? The first thing I’ll probably do is unleash my flowery expletives for a good hour or so; the poor souls in the area would need to get out, fast.
So what does this story have in common with your emergency fund? Like your foundation, unless you think to have a closer look, you will easily miss it thinking “well, I’m sorted!” And yes, you are sorted; until some calamity hits. How many times have you known friends or acquaintances who left their car at home to rot because they can’t afford to replace some parts? If this situation can cause them to abandon their property worth thousands, think of bigger, worse situations. What if they need to fork out for an even worse unforeseen circumstance; like retrenchment or overseas medical bills?
What is an Emergency fund?
Before I ramble on more and forget, let’s talk about what an emergency fund is. Basically, it’s money you have set aside for situations that demand more than your monthly budget allows. These situations are often beyond our control or you could say they’re… wait for it… Emergencies.
Of course, if everyone had money under their mattresses, we wouldn’t even need to worry. But the reality is most of us are not liquid financially. Liquidity, like the name suggests, means you’re able to “float” above any financial obligations. Without it, you’ll highly likely land on your face at the bottom of the pool!
How to set up an Emergency fund?
Remember one of my earlier posts about saving up? It’s basically that! Except your goal here is to save up a nice little money cushion. If you can’t be bothered to click the link, let me summarise:
1. Choose a savings account
There’s quite a few bank accounts in Brunei you can choose from. You could choose from personal preference, convenience or more importantly, their interest rates!
2. Decide on an amount to put aside
You could start small like $1 a day ($30 per month) or, as I prefer, use percentages. I personally put 15% of my paycheck away per month and on months where I don’t spend as much, I could up it to 20%.
3. Set a target
How much of an emergency fund do you need anyway? Wells Fargo suggests between 3 to 6 months of your expenses. I think this is a good rule of thumb but I’d go so far as to stretch it towards 9 months worth of expenses.
4. Be disciplined
Set your mind (and wallet) to it and make it a habit that the first thing you do with your paycheck is take a chunk and save it. You’ll thank yourself for the divine blessings from being more disciplined in the future!
5. Bonus tip: Hacking your growth
Here’s a life hack I learned and practice: any time you come into extra money, i.e. money NOT from your job, bank it into your savings! You’ll be surprised how fast your funds accumulate if you simply stop the impulse to spend all your extra cash. And yes, I said don’t spend all. Doesn’t mean you can’t spend some of it; personal finance is supposed to have meaning in your life, not be a self-torture instrument. So enjoy the ride!
When should you use your Emergency fund?
Generally accepted wisdom suggests that you should dip into this fund for anything related to an unforeseen event. This could be things like your:
- Job loss as part of retrenchment but you can survive for 6 months (or however much you saved up for) while looking for alternative jobs!
- Car breaking down unexpectedly and need some expensive part replaced,
- Mechanic servicing your car telling you that you need some expensive part replaced,
- Flight is cancelled while you’re overseas and you did not buy a travel insurance,
- Cat got into your chocolate vault and ate all your precious Patchi and Royce chocolates and need immediate veterinary attention.
And so on, and so forth. I personally practice not touching the funds as long as I can handle it (usually by sacrificing a dinner out with friends or two, but hey, worth it). It’s up to personal style how you set your threshold to “push the red button”, so to speak.
What should you do if you used your Emergency fund?
Hurrah! You survived a financial calamity! What do you do? Book a fancy dinner at Senja Lounge to celebrate? Of course not! We’re all responsible people here, right?
You continue to build the fund! It’s a never-ending cycle because even if you hit your target, the next thing to look for is:
Grow your wealth
Congrats! You’ve set up an emergency fund and it’s filled to your target amount of 6 months expenses. You should be wondering, “what’s next?” And while this milestone is no small matter, (many people are financially illiquid as it is) this will be the best time to determine your next goal. You now have some financial buffer to build on so you can look into:
- Investing in things like:
- Managed funds
- Real estate
- Business venture
- Risk management through financial products e.g. insurance
- Saving up for big goals like a house or car
- Saving up for smaller goals such as a long-needed vacation
It’s all up to you!
Can’t I just invest all my money without an emergency fund?
Of course you can! This was literally my mindset when I first started out. But think about this: If you lock up $10,000 in investments and you suddenly need to use it, how likely are you to lose money from selling them at the “wrong time”? What about the time taken to liquidate these investments; what if you need the money now?
Liquidity in itself should be an asset in your portfolio! Even if your risk appetite is obscenely aggressive, it’s probably worth it to have the peace of mind of having cash you can access easily.
Building an emergency fund may not be an obvious objective unless you have specifically come across it somehow. Like a good foundation for building a house, a solid financial foundation allows you to build your wealth with a certain level risk mitigated. This is the risk of being forced to prematurely sell assets to cover unexpected expenses.
Establishing your fund is very easy once you get into the habit of it. Best of all, this habit will translate into building up funds to invest too!
The way to build your savings is by spending less each month.
– Suze Orman