Prepare for the unexpected - Emergency fund alternatives
So, here’s the scene, Monkeypox is breaking out, we all rushing to look at our socials as usual…
What happens now?
A new virus? A new pandemic? A new way of life? Armageddon? End of the world? Or just finding yourself in a situation where you need liquidity or access to cash for emergencies?
Now, what you don’t want to do is sell investment positions you had a long-term view on. Why not? Well, what happens when we have the perfect storm brewing, and the market is down, I mean look where we find ourselves currently… rolls eyes…
Now imagine you need to sell those long-term positions for a loss, so you can cover short-term expenditure, due to a dive in the market…
These are the things that bring tears to my eyes…
Or imagine being a property investor – no not Balwin, and having to sell a property with a long term view, during a down market, with high interest rates (thank you SARB, NOT). So again, selling at a loss, because you need liquidity or access to cash in your financial plan – so you can cover expenses during emergencies. Talk about a property market crash…
Let’s be real, we have all been here, where an emergency catches us off-guard. You were not prepared, So let’s change that, and let us at BankerX help you to realise your potential and prepare for an emergency – whether the emergency is a broken car, a pandemic, or losing of your job – which is the worst outcome – as you are short a primary income in your financial plan – and yes, we can even prepare you for that.
So, the following is very important:
Your must have liquidity in your financial plan. Allowing you to have access to money quickly, without having to sell long-term positions at a loss to pay off these expenses.
So how much emergency funding do you need?
This remains a very contentious issue – some people say 3 months, some say 6, some say 12 and many more say 24 months. This is something you need to discuss as a family and with your independent financial advisor – based on your budget, expenses that you need to cover, and for the period you would like to cover.
As someone that is independently contracted to provide consulting services, my buffer is 6-month worth of emergency expenses cover. Again, some freelancers provide for 24 months, and others believe nothing more than 3 months, as they don’t want their monies laying idle, and not making more money…I mean isn’t that what we all wish for?
What do I consider in my budget when calculating my emergency funding?
Again, this is something that changes from person to person, depending on their needs and wants. If you aren’t sure, check your budget and get an independent financial advisor if you need further assistance in working out what funding you need.
I like to cover the major expenses in our household, so the wife and I would join our expenses together, and ensure that we can cover these over a 6 month period, with liquid accessible cash, before we would need to look at exiting long-term positions to free up cashflow.
What expenses are these you ask?
- A bond – yes, I know plenty don’t have these problems, bless your souls, but if you aren’t paying a bond, you are paying rent… make provision for it,
- Transport costs – whether this includes paying off a car, insurance, maintenance and petrol, or just simply transport costs for getting to and from work via taxis or public transport – you must budget for it,
- Food costs – ensure that you budget for food during these difficult times, you will still need to eat,
- School fees – if you have kids, you still need to pay school fees, I know right… schools are very expensive, trust me on this one…
- Medical Aid – what if something happens? And you need medical care?
- General expenses around the house – these depend on family to family, but would include things like insurances (death and disability cover), short-term insurance like your house building insurance, DSTv, internet or fibre, cell phone contracts and costs and anything else you are paying as a general expense.
Another important thing to learn in the long run is how to contain your expenses, therefore providing you with the ability to reduce your emergency savings requirement – and start investing in other opportunities or investment vehicles.
Are there other alternative investment vehicles you can use to store your emergency savings? Other than my bank account?
The short answer is yes. What options do you have? Here are 5 methods you can consider using going forward:
1. Your Bond Access Facility
Sometimes, and just sometimes, it does help being a homeowner. So, your bond is one of the cheapest ways for you to borrow money from the bank. Banks allow you to have an access facility on your bond, which means that any additional monies you pay in – you can access at a later stage – tax-free as your bond is paid with after-tax monies.
By paying in additional monies, you build an emergency fund in your access bond facility. Why is this a great idea? Simply great because:
- The return you get is the rate on your bond and what you are paying them. So, let’s say after the last repo increase (check my thread on repo rates here) your new home loan interest rate is 8%, that means any additional monies you pay over and above the normal bond – gets this return, in your favour – and you are cutting your bond timeframe down from 20 years to less, depending on the additional amount paid,
- And you can access that money immediately.
Just make sure your bond provider has given you this option before you decide to take this route.
If you are renting, sorry for you ne.
2. Fixed Income Fund
I personally opened an account like this with an investment provider, where I pay over a monthly amount, and every now and then, top up with lump sums. These type of investment portfolios consist of the following asset classes:
- Bonds, and
- Cash instruments.
With the current repo rates increasing, with more on the horizon, there is room to consider a fixed income investment for your emergency savings. This provides you with a better return than what you can get at the banks – I mean who likes below inflation returns after fees are paid? Provides reduced risk, versus your long-term investment, and it is a safe place to store your emergency savings – and at the same time generate a decent return.
The other benefit here is the accessibility of the emergency funds. Mine is invested in an unit trust, and I can access that money within 2 to 5 working days when I have an emergency.
This option provides me with the knowledge that my emergency savings are growing at a decent return, with low risk or volatility, in my financial plan and I have access to that money within a short period. I mean it’s just a bonus!
3. Money Market Fund
A money market fund is also an option you can consider. However, the returns will be lower versus a fixed income fund. The main difference between the two is that a money market fund would be highly liquid, you would have immediate access to your monies, as these funds include cash, cash equivalents, and short-term debt based securities.
In essence your return will be higher than your normal cheque account, but less than a fixed income fund.
If push comes to shove, and you are still busy building an emergency fund or you don’t have access to one yet, you can also consider the following two options – but please consider these two options carefully, speak to an independent financial advisor first, and understand the terms and costs of using these methods:
4. Short-term loans
In an extreme event, depending the nature of the emergency, and depending on the time you have, a short-term loan can provide you with a quick stopgap, especially if you are in a pinch.
Remember, this type of short-term loan carries with it rates and terms that you would need to agree to, and you will sign a document to that effect. However, this is not a permanent solution – and you should really consider building an emergency fund, rather than access debt, to pay expenses. I’m sure you get the picture.
But we have all found ourselves in difficult positions – my advice here is to understand the terms and conditions you sign – before you take any loan to cover expenses.
This is by far the worst solution on the table.
5. A credit card
Yeah, I’m sure you already have one… and no you shouldn’t be using it to maintain a lifestyle you cannot afford.
However, you can use it as an emergency stopgap, again, your bank will provide you with a facility to access money belonging to the bank. So let’s say your expenses are R15 000, and you have a credit card facility for R15 000 – it means you can effectively cover your expenses with your credit card for a month.
Just remember you using the bank’s money, not yours, unless of course you have pumped some extra green into your credit and it’s a positive. Go on you good thing.
But borrowing from the bank on your credit card is usually not the greatest idea, due to:
- High interest rate – and guess what, they’ll keep climbing,
- Easy to fall into a debt spiral – trying to maintain an impossible lifestyle – know your limits, and
- A false sense of security – why? You are using the banks’ money to cover expenses in the short-term – and again is not a permanent solution.
When you borrow money at the bank, there is always interest payable over and above the amount that you are borrowing.
Again, before you venture into these options blindly, speak to an independent financial advisor – who can provide you with guidance and could find an other alternative. This solution is second very close to the short-term loan option.
In conclusion, think about this:
Cashflow is king and your financial plan should include an emergency savings component for all those unfortunate emergencies.
An emergency fund provides:
- Liquidity allowing you to service expenses in the short term,
- And stopping you from accessing long-term investment vehicles art a loss to service expenses in the short term, and
- Last but not least, PEACE OF MIND.
This will get you running in the right direction. Once we have liquidity, you are in a position to spot opportunity and other investment options.
I will never stop contributing to my emergency fund, I like seeing it grow, but I also divert contribution to other investments once I have my 6-month savings in place.
And always remember – cash flow remains king!