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Are you one unfortunate incident away from having to borrow money? Sabotaging your careful budget or raiding your savings and scuppering your chances of reaching your financial goal?
Many South Africans are woefully underinsured and have no savings set aside for financial emergencies such as a job loss, a salary cut in a pandemic, a car that breaks down, the excess on your insurance or even a major appliance blowing up.
If you want to protect your budget, avoid debt and continue your path to saving for your goals, you need to have an emergency fund – money set aside that you can readily access to meet any unplanned expense.
If you don’t have such a fund, you’ll be forced to borrow. This will cost you in interest if you take a bank loan or burden your family and friends if you lean on them for help.
How much should you save
Financial advisers recommend at least three times your monthly salary – but six is a bigger safety net especially when you think how long it can take you to find another job during an economic downturn.
That can sound like a lot of money and a difficult savings target to achieve, but don’t let that put you off starting. Any money you set aside for emergencies is better than nothing and can help reduce the amount you have to borrow or divert from your goals in a crisis.
General rules are always imperfect when it comes to specific situations and you should be guided by your financial circumstances.
Consider the different emergencies you could face and think about whether you have any cover for them and at what level – for example, do you have cover for a medical emergency through medical scheme membership, gap cover, severe illness cover and/or temporary disability cover?
And in the case of a home or vehicle emergency, do you have short term insurance or a vehicle maintenance plans? What is your excess on your short-term insurance policy?
Then think about retrenchment or a pay cut as a result of something as unpredictable as the Covid-19 pandemic. What could you do to survive such an eventuality? How much could you scale back your expenses, and what retrenchment package would you be entitled to? How many other earners are there in your household? Do you have cover for your debt in the event of retrenchment? Read more: What is credit life cover?
If you have debt beyond manageable ones such as your home loan and vehicle repayments, your primary focus should be on repaying that costly debt, but setting aside a small amount for lesser emergencies can prevent you from borrowing more for some eventualities, while you are trying to pay your debt down.
Where should you save?
1. Immediately accessible accounts
Emergency savings should be available in an emergency. If you need to pay the excess on your insurance or to pay for repairs to your vehicle, you want to be able to access that money immediately.
For this reason, saving your emergency fund money in a bank savings account or money market bank account is wise, as you have immediate access to the money. A money market unit trust fund may also be used if you can wait for the 24 to 48 hours it may take to get your money.
However, bank savings and money market accounts often do not earn enough interest to keep pace with inflation, especially if your savings are above the tax exemptions. Remember that you are entitled to earn R23 800 in interest each year tax free if you are under the age of 65, but this limit applies to the total amount of interest you earn across all your investments.
If you are over the age of 65, you can earn R34 500 in interest each year.
2. Longer-term access
If you will have access to sufficient credit on a credit card in a financial emergency, you may be able to invest your emergency savings in a notice deposit account with a slightly better interest rate, because you would be able to give notice and pay off the credit card within the interest-free period.
Retrenchment is likely to be one of your most expensive emergencies. If you are employed, you will get notice, notice pay and severance pay. If you are self-employed or a contractor, consider what cashflow you would have if you were unable to trade or service your clients, and if you are entitled to any notice on your contracts.
If you are entitled to notice and severance pay, it means you could save a smaller portion of your emergency savings in a bank account or money market fund and the balance that you would require for this kind of emergency in an account on which you can give longer notice, depending on how much severance pay you expect you could get.
By law, you must be paid one week for every completed year of service.
3. Your home loan
If you have a home loan that offers you access to money you have paid in over and above your required monthly repayments – a flexi or access bond - this may be a good option for some of your emergency savings. While the additional money is invested in your home loan, it will save you interest.
However, make sure you understand your home loan providers’ rules around accessing that money – there may be conditions and limits on how much you can draw out.
4. Income unit trust fund
If a home loan is not an option, you can also consider an income unit trust fund (short-term interest bearing fund) or a multi-asset income fund as an option for some of your emergency fund savings.
An income fund can invest in fixed interest instruments with longer terms to maturity than a money market fund. It can therefore deliver a better return, but you will also take a little more investment risk than you do in a money market fund. You can access your money within 48 hours, but the recommended investment term – the period for which you need to remain invested to earn a reasonable return - may be between one and two years.
A multi-asset income fund is allowed to invest up to 10% in shares and 25% in listed property. This makes your potential for returns higher, but also increases your investment risk and with that, the risk that your investment may be slightly down when your emergency arises and you need the money.
Your money in a unit trust fund is accessible within 48 hours, but the recommended investment terms on these funds varies between one and three years.
