On Consultwho.sg, we recently received a question about emergency funds. A user asked us how much to set aside in case of sickness or unemployment. The user earned about $4,000 monthly, and saved half of that. In this article, we'll share with readers what an emergency fund is, why everyone needs one, and how to go about setting it up.
What is an emergency fund
An emergency fund is a sum of money set aside to deal with emergencies. The following are some common circumstances when an emergency fund is needed:
If a person is retrenched or switching jobs, there is a period of time where he or she will not be earning a salary. In this case, an emergency fund can provide a sum of money to cover living expenses before another job can be found.
2) Vehicle Accident
If a car accident occurs, an excess, also called a deductible, may need to be paid. An excess is the first amount of the claim the insured has to bear. This amount ranges from a few hundred, to a few thousand dollars, depending on the type of car and type of insurance.
3) Medical Expense
Insurance schemes that have the co-insurance or deductible condition do not fully pay for medical expenses. This means that the insured has to share the burden of the medical bill with the insurer.
A deductible refers to the initial medical expense that needs to be paid by the insured. Co-insurance refers to the percentage of medical expense the insured is required to pay. If either the deductible or co-insurance term is present in an insurance contract, the insured will need to set aside a sum of money in the case of unforeseen medical expenses.
Starting an emergency fund
An emergency fund can act as a buffer against market risk, as stocks and assets such as property do not need to be sold at inopportune times to meet emergency cash needs. This avoids a 'double jeopardy' type of situation, when stocks are sold cheaply during a market downturn to meet emergency cash needs.
First, estimate your monthly expenses. For individuals, estimating the size of an emergency fund is as simple as writing down monthly expenses for a few months. For households, expenses of every member of the household will need to be accounted for. Car or property debt payments, or credit card bills should also be included.
Next, decide how many months' worth of expenses the emergency fund should be able to cover. For young working adults, three to six months' worth of expenditure should be sufficient. For families, the breadwinner should consider setting aside nine to 12 months' worth of expenses in the emergency fund to provide for unexpected situations.
You should treat the act of contributing to the emergency fund the same as paying a recurring bill. Set aside a fixed sum every time a monthly salary is received, and transfer the sum into the emergency fund account before spending on anything else. To simplify the process, set up a recurring transfer instruction in your internet banking account, or do it the old fashioned way by filling up a GIRO form.
Married men can consider saving for a rainy day the Japanese way, by allowing their wives to control the finances, and leaving the emergency fund allocation to her instead.
Finally, decide on where to store the emergency fund. The emergency fund receptacle will need to be liquid and accessible, and be exposed to as little risk as possible.
One option is the UOB One account gives up to 3.33 per cent interest (effective interest rate is only about 2.4 per cent for funds of $50,000) if you fulfil certain criteria. It is a savings account so your emergency fund will be highly liquid and accessible, while being exposed to a negligible amount of risk.
Other possible vehicles for your emergency fund are fixed deposits and the Singapore Savings Bond (SSB).
Fixed deposits require you to set aside your funds for a period of time ranging from three months to as long as three years. In return, they offer you a higher interest rate compared to savings accounts. Prematurely terminating a fixed deposit will usually only result in the loss of interest accumulated, and not additional penalties.
You can also choose the SSB, which is a security offered by the Singapore government that provides individuals a safe and flexible way to save for the long term. However, the SSB is not as liquid as fixed deposits or savings accounts, as it requires one month notice to redeem.