Why You Need an Emergency Fund, and How Big it Should Be
21 August 2020
If you’re like the majority of Singaporeans, a sudden loss of income would spell financial disaster in just a few months. OCBC’s Financial Impact Survey for COVID-19 revealed that only 70% of Singaporeans earning more than $2,000 a month had enough savings to last 6 months or more. 18% would not make it even one month before running out of cash. Those are certainly dire statistics.
The expected job losses and pay cuts accompanying the COVID-19 pandemic have driven home the importance of being financially prepared. While global crises and disasters are out of our control, there are things you can do to fortify your finances and make it a bit easier to survive the difficult times.
Why do you need an emergency fund?
An often-overlooked aspect of financial planning is the necessity of creating an emergency fund. What this fund does is ensure that you have a pool of funds to draw upon for unexpected needs, such as a sudden job loss or medical emergency.
You should keep it in a place that is safe from market risk (i.e. not invested in the stock market) and highly liquid (i.e. able to be accessed immediately). A simple savings deposit account would suffice. If you’re hoping for a better interest rate, you can also consider opening a money market or fixed deposit account.
How much do you need to save?
Conventional advice says that your emergency fund should have enough to cover 3 to 6 months’ worth of expenses. However, when funds permit, we would recommend increasing that to 12 to 24 months.
COVID-19 has been around for almost 8 months now. Its impact on the economy has been unprecedented. The job market remains uncertain, and there are fears of a protracted recession looming. The world is unlikely to get back to normal any time soon. Hence, the longer your savings can last you, the more breathing space you’ll have to find new sources of income.
How do you get started?
Start by keeping track of how much you spend each month. If you have not, now is as good a time as any to start! Record down everything you buy, no matter how small. Once a month or so, plug those figures into a spreadsheet to see if there are any new patterns over time and which areas you may be overspending (or can afford to spend more) in.
Work out your monthly fixed costs. These are fixed payments you have to make every month, such as rent, mortgage, bills and insurance. Figure out what your necessary living expenses are. What do you usually spend on variable costs, like food or entertainment? What is the minimum amount you’ll need to survive each month?
From that minimum amount, calculate your savings target to work towards. If you’re lucky enough to have already surpassed that goal, you may want to set that target amount aside – such as in a separate bank account – to keep yourself from accidentally spending it. Your emergency fund should only be used for emergencies.
If you don’t have enough funds yet, as long as you have an income and are able to cover your basic necessities, you can slowly channel the excess into building up your emergency fund.
This may mean temporarily going without some things you normally enjoy, but as a crisis can hit at any time, you want to have this safety net up and ready as soon as possible. Start saving while you only have to go without luxuries. Don’t wait until you’re out of money and have to go without necessities.
If your income is currently low or you have financial obligations that leave you with little or nothing left each month, don’t be afraid of starting small. Any amount you can set aside is still better than nothing. If you end up earning more in future, you can increase your savings accordingly.
The most important thing is to start. Be consistent and develop the habit of saving. Most people can become financially independent by what they save rather than what they earn. Having a ready source of funds for emergencies will go a long way in helping you weather unexpected crises, and give you some valuable peace of mind.
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