How to build an emergency fund
An emergency fund is a great way of protecting yourself financially. Unfortunately, things can happen that we can’t plan for like family illness or car problems, which cost us money either through additional bills or time off work. Having savings to rely on during these times will prevent falling into debt. Financial experts suggest, as a rule of thumb, that your emergency funds should equal around 2-3 months of income.
In reality, though, saving toward an emergency fund can be very difficult. We have previously highlighted the lack of disposable income available to the average South African household. Our article on Debt Review numbers showed that only 23% of us have enough money each month to save, whilst 60% struggle to meet debt repayments. Transunion recent Q3 infographic highlights that household cash flow is at its weakest since 2009 with 3.4 million credit accounts in arrears. As a nation, we are living paycheck to paycheck, which has allowed the payday loan and credit card industries to flourish as they become the easiest route to money in times of emergency.
As difficult as it may be here are some top tips to help set up, and build, your savings for emergencies.
Repay before you save
You should prioritise repaying your existing short-term debt before you start saving. You are paying interest on a debt, the cost of which will outweigh the benefits of saving money. Aim to pay off your highest interest rate debt first such as a payday loan. You can reduce the cost of interest by consolidating credit card debt to a low-to-zero-interest rate credit card through a balance transfer.
Review your expenses
Reviewing your monthly expenses can be a useful way to free up some extra cash to save, especially if your disposable income levels are low. List all your bills such as rent, mortgage, car payments, utilities, food and leisure. See if there are any areas you can ‘cut back’ on spending, putting the money towards savings instead.
Set a goal
With anything in life, setting yourself targets will help you keep focus and stick to the plan. Set a total saving goal, like 2 months income, and work out how much you can save from each payday. You can then calculate how long it will take you to reach your total saving goal for your emergency fund. If you want to build your savings quicker, you could think of ways to make extra money such as selling old clothes.
Although not essential, setting up a direct debit from your regular bank account to your savings account will ensure you are building up your savings each month. You can set up the direct debit to transfer the amount you calculated in the previous step to remain on plan. Whatsmore, you can forget about your direct debit once set up and your savings will accumulate automatically. When you finally remember you were saving, you may be surprised by how much you have saved.
Bank additional cash
If you receive extra money from a work bonus or a birthday present, try to resist the urge of going on a spending spree and deposit it into your saving account. Adding to your savings whenever possible will help you reach your goal quicker and, more importantly, secure your financial safety blanket.
This should give you a good starting point but your success in growing your emergency fund will depend on your individual determination and discipline. Avoid dipping into your savings as one day it could be a lifesaver!