Understanding Emergency funds

Covering all you need to know to protect yourself againts lifes little curveballs.

Understanding Emergency Funds

Emergency funds remind me of the Alanis Morissette song Ironic, where she sings about rain on your wedding day. It's a free ride when you've already paid, it's the free advice that you just didn't take, and who would have thought it figured? Some people call this karma or Murphy's law, but whatever it is, it applies to personal finances too. I'm sure all of us have examples of experiences where you're having a bad month financially and something breaks on the car too, this is where an emergency fund comes in.

What is considered an emergency fund?

An emergency fund is savings set aside to act as the protector against life's little curveballs, or when lady Karma wants to strike, or Uncle Murphy comes knocking. An emergency fund will be the saving grace that will prevent you from falling into debt when an emergency occurs. By being prepared for these emergencies, it's quite ironic that they likely happen less by being prepared. 

Characteristics of a good emergency fund

Your emergency fund should be separate from your daily banking account and not immediately accessible to avoid using your emergency fund for things other than emergencies. 

The funds should be highly liquid, meaning easily accessible. On request, the funds should be in your account within three days to ensure you can cover your emergency expenses. 

The fund should be very low risk, like an interest-bearing, highly liquid investment to provide security for your capital.

As the returns are very low in these types of investments, fees play an important role. Keep fees to a minimum.

Which funds are the best for emergency funds

The below money market funds are managed by investment managers. These are the top three money market funds that we will highly recommend for emergency funding use. Please note that this is not advice. We inserted links to the investing pages of these companies. When investing directly, you will pay no admin fees or advice fees. 

1. Prescient Money market account 

2. Allan Gray Money market account 

3. Ninety-One Money market account 

There are many of these money market funds available. If you don't use any of these top three suggestions, ensure that your fund complies with the characteristics of an emergency fund. 

How much should you have in your emergency fund?

A good emergency fund would cover at least 3 to 6 months' worth of expenses, excluding saving amounts. How much you specifically need depends on your situation. Let's state the two extremes first, and then you will get a feel for where your funding level should be, in general, more is better.

The safe extreme: The typical household for this scenario would be a two-income household, with secure and stable jobs, low expenses, and low overall risk. In such a scenario, use three months as your emergency fund. 

The unsafe extreme: The second scenario is the unsafe extreme, where the household has one income. That person works off commission only, combining an unstable work environment. This person can also be self-employed, with uneven cash flow and higher risk. In this scenario, lean toward six months of emergency funding. 

How long will it take to fund my emergency fund?

Below is the formula to calculate how long it will take you to save up your emergency fund. For this formula to be accurate, you will need to know your savings rate. Use this formula to figure out how many years you need to work to save up one year of expenses. 

Formula: One minus your savings rate divided by your savings rate: (1 - savings rate) savings rate. 

If you don't want to use the manual way you can download our Emergency fund tool to calculate how long it will take to save up for your emergency fund. 

In summary

Your emergency fund is not only an important building block to financial independence, but it will also provide you with comfort, knowing that you are prepared for whatever life throws at you next. Make sure after an event that your fund stays replenished before you continue on your investing journey. 

If you want to find out more about becoming financially independent, please see our free course. If you want a blueprint toward financial independence, you can enroll in our Stages to financial independence course.

Onward to Financial Independence 

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