“Prepare for eventualities since things can change in a second. You need to have back-up plans just in case.” – Muthoni Ndonga
Life tends to happen without warning. It’s lovely to dream about the great lives we could lead once our savings start to pay dividends (if you’ll pardon the pun). Happily, saving is not all about delayed gratification. Sometimes saving is the only thing between the beautiful life you’re already living and a slightly worse, more stressful version. Saving is also the electric fence that protects your investments.
No one relishes the idea of slow, steady wealth creation. As much as we know we can only do what our income allows, we dream of a single investment that will change our lives overnight. We think we haven’t done it yet because we haven’t found the right investment.
The reality is far more boring. We can accumulate wealth only as fast as we can earn money. For most mere mortals, that means a salary. You might be wondering if you’re ready to take the leap and buy your first investment. There’s an easy way to check: the emergency fund.
What is it?
To the naked eye, an emergency fund just looks like a savings account with a big cash balance. Us in the know can recognise it as the one thing that will come through for us when we need it most, time and again. Family will fail us, partners will come and go, but the emergency fund will be there every time.
This completely down-to-earth, honest-to-Bob bank account is the first step towards becoming a true investor. That it doesn’t involve any investing is curious, sure, but not insurmountable. Don’t let the fact that you’ve had the answer to investing in your grasp since childhood put you off. Sometimes magic happens in unexpected places.
Why do I need it?
The emergency fund has a dual purpose. At face value, it bails you out when you need it. Real emergencies cost money. When you have an emergency and the cash to deal with it, you can focus on the emergency. When you have an emergency and no money, you have panic and debt. Neither of these things make your life easier.
The emergency fund is also there to protect your investments. Think of it as an electric fence around your hard-working assets. As we explain in this article, investing needs time to work. The price of an asset, whether it’s a share of a business or your own operation, depends on many factors beyond your control. If you have investments and no emergency fund, you’ll have to sell assets to deal with your emergency. If the timing is off, you might have to sell at a loss. This is literally the opposite of what you’re going for.
Fine, how much should be in it?
If you are employed full-time, you need three month’s worth of lifestyle expenses. If you happen to lose your job, you can look for another one without going into debt for three months. Note that you work on expenses, not income. Hopefully there’s a big difference between the two.
If you’re a contract worker or part-time employee, you need more fat in your budget. Your emergency fund should cover all your expenses for at least six months. You’ll probably use this fund to cover a shortfall in lean months, which is why you need more than a full-time employee.
Having enough money to get through a rough patch means you are ready to start investing. Your investments will have an electric fence against life.
This is boring
Yes, it is. Cash in an emergency account isn’t the sexy Future You on a boat. However, it’s going to get you closer to that person a lot quicker. No false starts for you, my friend.
OUTstanding Money blog
Being outstanding with your money doesn’t have to be hard. This series of articles will give you all the tools you need to get your house in order to start investing.
This series of articles was sponsored by OUTvest, and written by Just One Lap in 2018. It’s timeless wisdom that needs to be out there – in public spaces where it can feed into ongoing discussions about long term financial wellness. We are republishing this series to make outstanding Fridays (but you’re welcome to read ahead).