You've been following your budget, you've paid attention to all the tips, things are going a little better than you expected, you no longer struggle to cover your monthly expenses, you've even started to save a little bit, not a lot, just a few thousand left over in your account at the end of each month. You use it every now and then, 2 months ago, it was on a new pair of shoes, this month it was a spontaneous trip to Portland, the extra came in handy for gas and pork and pork, with extra pork.
Today, your boss called you into his office, sat you down, and explained that things aren't going well with the company, he values your work, and expects things to get better as soon as work starts on the new Logistics Hub project in 3 months. He doesn't want to let you go, and in fact, plans to make you project lead once the project starts, here's the problem though, he can't pay you until the project starts. You're now facing the decision, trust your boss, wait three months, and take the Project Lead position when it comes, or thank him for his time, leave the company, and start searching for a new job. Here's the squeeze, regardless of which option you go with, you're likely going to have to live without a steady income for a few months. Maybe you'll be lucky and land a job within a week, but that's doubtful, it's likely that you'll be without income for at least 3 months till your boss calls you back. So, how do we not fall into abject poverty within 3 months? The Emergency Fund, or Rainy Day Fund, as some call it.
WHAT IS AN EMERGENCY FUND?
Simply put, an emergency fund is a sum of money put aside to be used in case of emergency. That last bit is particularly important, it's not to be used on that oh so cute pair of heels that you saw earlier this week and just HAVE to get (no you don't). It's not to be used to pay for tickets for your vacation in a few weeks, or for that new phone that just got announced. It's for EMERGENCIES ONLY, the sort of thing where you KNOW you need it and you're suddenly thankful it's there. An example of emergencies that I've heard about from friends recently are;
* A friend started having serious headaches, his doctor sent him to a specialist who recommended a CAT scan. (CAT scans are conducted by running a series of high value monetary bills from your bank account through the hands of a specialist who feeds them into a machine you lay in).
My mother's car started making a strange sound. Turns out she needs to replace most of the front end in order to keep the car running. (A vehicle's front end, in Jamaica, is composed of a series of high value bills from your bank account which keeps the axle at the right height and the tyres on the road)
A friend was made redundant, got 2 weeks pay, and a thank you. She now has to live off her savings while job searching. (A redundancy is a corporate maneuver which removes you from a company's dependence list, and places you on base made out of your bank account).
Essentially, any large unplanned and necessary expense that comes along stands to be handled better if the person has an emergency fund. Without one, be prepared to suffer, or accumulate heavy debt, and then suffer. The fund may not always cover every emergency fully, but best believe it's better to have it to even help with costs than nothing at all.
So, now that we know what an Emergency Fund is, and what it's good for, we need to know how to set one up. To do this, we need to answer the question "How large should my Emergency Fund be?" Now, the experts vary greatly on this, Suze Orman (who my boss swears on) is popular for saying 8 months of living expenses. Others say 3 months, others say a year. From personal experience though, I know that even 3 months can be HARD to accumulate. Some things make it easier, things like managing your expenses, and saving aggressively, but building up even 3 months of full expenses in savings can easily take years, unless you have a nice budget surplus each month.
Personally, I say, don't hold yourself to a single number, instead, start with milestones, achievable numbers that you can see in a shorter period of time. So for example, I think that about $100,000 is good to have on hand should anything happen. While this isn't even 1 month of expenses for me, It's an achievable number that in a pinch can help me out. When you hit the milestone, start saving for the next one, in time you'll build up to the 3 month mark, then 6 months, then 8 etc etc etc.
You should also ensure that you keep the money in a place where it earns interest, or at the very least it won't be eaten away by fees. The Jamaican economy being what it is, I would strongly suggest saving for your emergency fund in US $, not only will this stave off the effects of inflation on your fund, but it may also provide growth in the long term. Opening a US $ account is a good idea, but not mandatory. If you can do it though, do it.
Now let's bring this back to our favorite imaginary client, Jerry. If you remember the budgeting article, you'll remember that Jerry's overall monthly expenses are $88,927. That means, that for Jerry to live comfortably as he's living now, he needs to have an emergency fund of $266,781 ($88,927x3). Based on his income that would mean saving $10,000 monthly (which he currently is doing) for 27 months. That's a big hurdle to jump over. Instead of getting daunted, Jerry does the wise thing, he writes milestones down.
Milestone 1 $39,000: This milestone allows him to buy groceries, keep his electricity and water on for 2 months and keep getting his hair cut, should he lose his job.
Milestone 2 $78,000: This is the same as milestone 1, just for 4 months instead of 2.
Milestone 3 $156,000: This is now 8 months of BASIC living expenses covered.
Milestone 4 $234,000: This is 12 months of BASIC living covered.
Milestone 5 $266,781: This is now 3 months of FULL living expenses, or 13 months of BASIC living expenses
Now, notice what Jerry did. He went with manageable milestones and immediately split his expenses down into essential and non-essential. No matter what, he will need to eat, and looking presentable will help him land another job, so the haircut remains. He doesn't actually concentrate on his full expense list until milestone 5, which is realistic, since if he loses his job, having a nice internet package and postpaid phone plan may likely become quite secondary. This is essential, you need to cover your basic living expenses before you start on your emergency fund.
Now to start it, Jerry opens an account at his neighborhood Credit Union, he DOES NOT TAKE A DEBIT CARD for the account. This is deliberate. It's best to have the money somewhere accessible, but not too easily accessible. There should be a bit of a barrier to accessing the money, so you can think about if you truly need it before you do.
Jerry also decides to start putting more of his surplus toward his savings. That will make the milestones quicker to achieve. He now starts to save $17,000 monthly instead of $10,000. This means he will hit each milestone according to the following schedule:
Milestone 1 $39,000: 3 months
Milestone 2 $78,000: 5 months
Milestone 3 $156,000: 10 months
Milestone 4 $234,000: 14 months
Milestone 5 $266,781: 16 months
Jerry is well on his way.
So now, let's review.
An emergency fund, is a fund that you keep in case of emergencies, and only real emergencies DO NOT TOUCH THE MONEY unless it's an emergency. You should build it up, at the very minimum, to a level you're comfortable with. 3 months of full living expenses is a common figure.
Keep the fund somewhere accessible, but not too accessible. Pro Tip: Use a separate account at your bank, but do not connect it to your online banking portal, and DO NOT TAKE A DEBIT CARD.
Save in US$ if you can.. The longer you do, the more your money will be worth. (Update: This was written mid-2015 before the BoJ implemented it’s new system. Currently (mid 2019) I would not recommend saving in USD unless it’s a set part of your plan and you have considered the possible losses from doing so. The days of the JMD/USD rate only going up are gone. Bear this in mind)
Map out a plan with milestones for building up to your ideal fund amount. Feel free to reward yourself with a splurge (within budget) whenever you hit a milestone.
I hope this article helped you, feel free to leave a comment or tweet at us letting us know how your fund is going or if you have any questions.
See you in the next one.