An Emergency Fund
One thing everyone should have is an emergency fund. This is basically a short term financial plan, where you have a sum of money put aside in an instant access account and available for emergencies. It is basically accessible cash, and is not to be considered money that can be speculated with, or used for indulgences because things look healthy financially.
The point of an emergency fund is that you should have enough money to be able to see you through if a minor disaster strikes, without needing to affect other parts of your longer term planning, or worse, resorting to debt.
It is in effect a way of “self insuring”. If you do have an adequate emergency fund set aside, then you are self insuring to a degree and it may be possible to reduce the cost of some of your regular insurance payments as a result.
As a general rule of thumb you should put aside 3-6 months worth of expenditure. If you are self-employed, you might want to think about extending this to perhaps a year’s worth of expenses, just in case the business hits particularly tough times.
What if you don’t have an emergency fund?
Well, you run the risk of dipping into other assets or savings, or worse. You may have to go into debt to fund the emergency requirements. Either will have a negative impact on your ability to save or invest for the longer-term, or to pay off other debt. There is a real risk also of incurring penalties such as charges, or have to exit other investments or sell assets at deeply discounted prices – creating an even bigger negative.
Avoiding bad debt
Many people who don’t have any savings put aside for the use in emergencies have very poor options when the inevitable emergencies do arise. With little savings and few liquid assets (which can be turned into cash quickly) they have to resort to using credit cards at very high interest rates or short term (payday) lending companies, also usually at relatively high rates. Having an emergency fund can mean saving perhaps 15-20% in costs from such debt, not to mention keeping your future cashflow intact as you don’t have to be repaying loans.
What to do
Work out how much you think you need for 6 months worth of living expenses. Then set up an account and transfer any excess income into it until you have that amount set aside. Don’t worry too much about the interest rate or return that you are getting on this money. If in doubt about what you really need, or where to put it, then get some advice. If you have an emergency fund set up already, then check on how you might be able to save a little on some types of insurance premiums.
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