| Emergency Planning |
An unexpected event can happen at any time that requires money. Who can tell when this will be? It may be a roof leak, a car breakdown, a broken leg, the loss of a job. Even if a loss is insured, the claim may take time to process and money is needed in the meantime. It would not be good to be forced to sell assets at the wrong time just to raise funds.
How much is enough for an emergency? That is a tough one to answer because only the individual who is aware of his own circumstances will have a feel of how much should be stashed away for an emergency.
One could say save as much as possible for an emergency. But an emergency fund by definition should be obtained immediately or almost immediately. Which means it should be in the form of assets that are very liquid. These would be cash or near cash, such as money market funds or bank deposits that are withdrawable at very short notice. And unencumbered, i.e. should not be earmarked or pledged for a loan that requires to be settled before the cash can be withdrawn. Obviously, such funds will earn a low return and have low risk (since such funds should not be subject to market fluctuations that deplete the amount set aside). Thus, one cannot put aside ‘as much as possible'.
 | Instead of getting too theoretical about what constitutes an appropriate amount, most people use a simple rule of thumb, which is to take a number of months of basic expenses (i.e. excluding luxuries or unnecessary expenditure such as golfing), usually three to six months. |
Try not to utilise the emergency fund for purposes other than real emergencies. For purposes that one can do without, such as house renovations, world cruise, and so on, a separate special purpose fund should be set aside.
Emergency Fund FAQs
1. | Can an overdraft be considered an emergency fund? |
A: | Any borrowing is not good for use as an emergency fund. First of all, draw downs from borrowings such as overdrafts carry interest. An emergency involves unexpected expenses and interest from borrowings would just add to the burden, particularly when there is a hefty penalty interest if repayments are behind schedule. Secondly, there is always the possibility of the credit line being withdrawn because of change in policy, breach of covenant or other reasons. So a credit line, unlike cash at hand, is not an assured source of funding for emergencies. |
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2. | Could not encashment of an insurance policy be used to cope with an emergency? |
A: | A surrender of an insurance policy before its maturity should be avoided unless there is really no choice because the loss involved can be substantial especially in the earlier years since the cash value would be less than the total of premiums paid. In the absence of an emergency fund or other alternatives, it would be better to borrow against the security of the policy and pay the interest. |
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