Emergency Money

 

Back to Money advice
22 June 2023
Congratulations on making it to the midpoint of 2023, and what a six-month period it has been! Trawling through various media sources the message is clear that these are uncertain times, almost as if the entire world is trapped in a state of emergency along with our finances.  

A high inflationary environment, international tensions, economic ambiguity, a local power crisis and a bumpy stock market are just some of the things weighing down on our finances. These uncertain times, once again, underscore the need for including a solid emergency fund as part of your financial plan.

An emergency fund is the foundation upon which any robust financial plan should be built. It frees up your finances, allowing your primary investments to stay on track towards achieving their intended goals. Sadly, and too often, people that don’t have an emergency fund in place are forced to withdraw funds from investments not intended or designed for emergencies. This unfortunately causes these investments to veer horribly off-course and fall hopelessly short of their projected investment goals, and in some cases causes profound financial distress.

The often underrated and underappreciated little emergency fund should be the starting point of your investment journey. Without an emergency fund your entire financial plan can be susceptible to attack during economic hardships.  Most of us are not immune to these economic hardships that will affect us at some time or another in during our life time.

Below are some pointers as to how to go about setting up a hands-on emergency fund:

Three building blocks for a solid emergency fund

  1. Cash is King

Money in an Emergency Fund should ideally be invested in cash, earning a competitive interest rate. Money Market Funds or Money Market Unit Trusts are great examples of investments suitable to house emergency funds.   

  1. Liquidity and Flexibility

Emergency funds must be easy to access and should payout relatively quickly. They should not be locked away, incur any penalties or other restrictions when trying to access these funds. 

  1. Stability

These funds must be highly regulated and protected. No risky business or high risk assets belong in an emergency fund. Sometimes investors are distracted by the notion of high returns, yet they do not completely understand the risk they are taking.

How much should you have in an emergency Fund?

  • To cover at least three times your monthly gross salary is a good start. However, each person is different and therefore seeking proper financial advice is highly recommended.
  • As cash is ideally the underlying investment class for an emergency fund, tax will apply. The good news is that SARS allows an interest exemption (tax free interest) amount where you do not pay any tax on interest earned in a tax year. Your emergency fund should ideally not exceed this SARS limit. If you are under 65-years-old, you can earn tax free interest up to R 23 800 and R 34 500 if over 65 in a tax year.

Who should have an emergency fund?

  • Everyone who is economically active. An emergency fund is similar to insurance in that it can bail you out and protect you from financial loss, with the added bonus that if you don’t need the emergency funds, you still have cash saved up and available to use as you please in the future.

The time for Emergency Funds is NOW!

  • The best time to build an emergency fund quickly is when interest rates are high – as they currently are in South Africa.

An example of a self-sustaining emergency fund set up

Jack set-out to build up an emergency fund to ensure that he is prepared for tough times.

He earns R 25 000 per month and realizes that he would need at least three times his monthly salary saved up to cover emergencies. Jack starts contributing R 2 000 per month.

Once Jack has built up his emergency fund, he stops contributing and the fund continues to earn interest growing well above his safety buffer of roughly three times his monthly salary, as illustrated below.

Jack was fortunate to have avoided emergencies for another three years after building up his initial emergency fund. Due to the compounding effect of earning interest on interest, his emergency fund added roughly R 20 000 more over the next three years, without him contributing a cent or paying any tax!

Additional uses for an Emergency Fund

  • Funding waiting periods for disability cover;
  • Medical related emergencies and additional ad hoc costs;
  • Unexpected school tours and trips; and
  • Funding Insurance excesses

Be savvy and secure your financial future with a low risk, tax efficient emergency fund as a matter of urgency!

 

Gareth van Deventer CFP®
Technical Advice Service Manager
OUTvest is an authorised FSP. Views expressed in this article is that of the financial advisor and not a full representation of OUTvest’s stance. All investments are exposed to risk, not guaranteed and dependent on the performance of the underlying assets. Ts and Cs apply.
Latest Money advice articles
2024 SA Budget Speech Highlights
OUTvest Quarterly Report Q4 2023
New Top Ten Tips for 2024