Protect yourself and your loved ones from life's uncertainties with AIA's life insurance and takaful plans.
14 July 2020
What is an Emergency Fund?
An emergency fund is money set aside for unexpected (usually large) expenses. Some good examples are – medical expenses, car repairs and maintenance and of course unemployment.
With the recent Covid-19 pandemic, it isn’t hard to imagine yourself in a situation where you’ve just been laid off. Then imagine a week later, your car breaks down and you’re unable to attend job interviews. Sure, there is public transport and ride-hailing services but wouldn’t it be better to have that safety net for such unexpected situations?
Another common scenario is when one is hospitalised and is either uninsured or his/her illness isn’t covered under their current protection plan. What is one to do in such a situation if money is an issue? An emergency fund, if set up properly will be sufficient to weather you through these unfortunate events.
While we’re on it, there is a big difference between regular savings and your emergency fund. There must be a distinction between the two. Your emergency fund has to be absolutely liquid and only used during a genuine emergency. While your regular savings can be placed in less liquid instruments and it will eventually be utilized to invest in assets.
Why is an Emergency Fund important?
From a financial standpoint, having an emergency fund acts as a buffer. Without it, you’ll be forced to liquidate your investments to solve your immediate emergency conundrum. And more than likely, it may not always be a good time to sell off your stocks or your investment property.
As a long-term stock investor, I plan to hold on to my stock investment for years. An emergency fund is vital for me to prevent unnecessary liquidation of my portfolio at an unsuitable time.
As mentioned earlier, peace of mind comes hand in hand with an emergency fund. Knowing that you’ve got some money squared away for a rainy day will help mentally. It’ll give you the confidence to take risks and make bold investments which you’ll never take if you didn’t have that safety net.
Most important of all, you’ll be able to make better financial and investment decisions when you have money saved up for emergencies.
How Big Should my Emergency Fund be?
Your emergency fund can be calculated in two ways. You either base it off your monthly expenses or your monthly income. Personally, I base mine on my monthly income.
As a rule of thumb, you’ll want to have 3 to 12 months of your monthly income saved up for emergencies. I suggest starting small, start saving up for 3 months, go to 6 and if you still want a bigger safety net, go for a year’s worth.
Personally, I have a 24-month emergency fund stashed away. I started off with a 6-month emergency fund. And as my investment portfolio grew, I eventually increased it to a 12-month and then a 24-month emergency fund.
How to Set Up Your Emergency Fund.
Before even thinking of investing, it is my opinion that you should have your emergency fund set up first. Because, as I’ve mentioned, you want to make sure you don’t have to liquidate those investments in times of need. You don’t want distractions. You want to have that razor-sharp focus when making your investing decisions.
If you don’t already have an emergency fund set up, the very first step is for you to take out money from your savings, if you’ve got your 6 months’ worth right there, you are set. If not, you’ll have to save up. And then only do you think of investing.
Your next question should be – where do I put my emergency fund?
First, you’ll want it to be as liquid as possible. At the same time, it has to be generating interest for you because, an emergency fund could come up to a sizeable amount. For example, a RM5,000 a month salary man could have a 12-month emergency fund of RM60,000.
Personally, I put mine in short term 1-month fixed deposits. I practice something called FD Laddering.
It is basically breaking that RM60,000 into a few FDs on different days of the month. This helps you lose less interest when liquidating.
Money Market Fund
An alternative to fixed deposits for your emergency fund would be a money market fund. A money market fund is essentially a mutual fund that invests in very liquid assets such as cash, cash equivalent securities, and high credit rating debt-based securities with a short-term maturity.
High Interest Savings Account
There are some savings accounts that offer high interest and can be a good alternative to fixed deposits. There are usually some conditions to fulfill before you’re eligible for the high interest.
What Comes After I’ve Set up my Emergency Fund?
Save, Save and Save!
Congratulations, you’ve got your emergency fund set up, what’s next? Continue saving.
I cannot stress how important savings are in the wealth building process. Without saved up capital, you won’t be able to take advantage of a market downturn when it comes around.
As a stock investor, my purchase price determines if I’m making the right buy. Price and value of a stock is everything as I hold my stocks for the long term.
If you, like most people have trouble saving, you might want to check out a few articles in AIA’s database on savings. Insurance companies like AIA offer saving plans specifically for this reason.
Below are some helpful articles on savings by AIA.
After saving, you’ll then want to invest. Pick an asset and pick an industry you’re familiar with.
Invest in what you’re comfortable with and invest in an asset that you know and understand. Invest with a goal – is it a monthly stream of passive income you’re looking for? Or maybe your goal is to own assets that appreciate over time like properties. Whatever it may be, you have to invest in assets.
For me personally, I invest in stocks and the dividends I receive from stocks are my passive income. It is what I know, and it has been my passion for the last 10 years. It still is.
I guarantee you that you’ll make better financial decisions with your emergency fund set up. So, get to it if you haven’t already. As always, onwards and upwards!
The above articles are intended for informational purposes only. AIA accepts no responsibility for loss which may arise from reliance on information contained in the articles.
Leigh is an investment and personal finance author at https://dividendmagic.com.my/
He is a Certified Financial Planner and a value investor with a portfolio mainly consisting of stocks.