Building an Emergency Fund

Emergency funds are funds set aside to be used in urgent situations such as the loss of a job, an illness or a major expense. The purpose of the fund is to improve financial security by creating a safety-net of funds that can be used to meet unforeseen expenses, as well as reduce the need to use high interest debt as a last resort.

Irrespective of all the demanding expenditures, having an emergency fund is a necessity. Financial experts recommend that people maintain a cash reserve large enough to cover three to six months’ worth of household expenses. To quote the American poet Henry Wordsworth Longfellow: “Into each life some rain must fall, some days must be dark and dreary”. Perhaps the person who coined the expression “save for a rainy day” had Longfellow’s words in mind when he or she spouted those often repeated, and often ignored, words of wisdom. Here we look at how much you’ll need to save for your emergency fund, and how you can get started today.

What Must I Do?
An emergency fund is a great idea, but it also requires some effort to achieve. The first step in the process is to figure out how much you spend each month. Let’s assume that the average expenditure per household is GH¢12,000 per annum. This data is broken down by month in the table below. The months in bold highlight the cumulative quarterly expenses, and therefore the recommended cash reserve for the average household.

  Number of Months   Cumulative Expenses
1 GH¢1,000.00
2 GH¢2,000.00
3 GH¢3,000.00
4 GH¢4,000.00
5 GH¢5,000.00
6 GH¢6,000.00

While your household expenses may be higher or lower than the average, there’s no doubt that even three months’ worth of expenses is a big number. A quick look at that number and the average person’s first reaction will be, “I can’t come up with that kind of money”.

The amount of money required to fund a proper emergency fund is certainly significant, but we live in uncertain times with uncertain economies. Corporate loyalty is a thing of the past and unemployment can happen unexpectedly, usually at the worst possible moment. Likewise, emergencies like sudden illness or disability, car repairs or a new roof can be expensive, and there’s never a ‘good’ time for these things to happen.

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Estimating the Figures
Now that you have things in perspective, it’s time to start saving. Approach this effort the same way you would approach any other financial goal. Put together a plan and execute it. The first step is to determine how much you spend each month. Housing, transportation and food will likely be the three categories that take most of your cash. The average consumer spends about 65% – 75% of his or her income on these items. Once you know your total expenses for each month, multiply that number by three. Reaching that number will be your initial goal. To achieve your three-month target, you need to start saving little by little.

If we assume your initial goal is GH¢3,000 the table below illustrates how much you will need to save each month, over a four-year or a two-year period.

4-Year Plan Amount needed to save  per Month 2-Year Plan Amount Needed to save per Month
48 months GH¢62.50 24 months GH¢125.00

Acting on Your Plans
Buying a less expensive car the next time you are shopping for a vehicle, buying fewer shoes and reducing the talk-time on your cell phone service are easy ways to come up with some cash to fund your savings plan. Cutting down on the amount you spend dining out, and saving your next raise or bonus are also simple methods of adding to your emergency fund.

Ideally, you should treat your emergency fund like any other recurring bill that you must pay each month. Dedicate the appropriate amount from your paycheck and set it aside. While most people have no qualms about sending enormous amounts of money to mobile phone companies and spending on clothes and shoes on a regular and systematic basis, they balk at the idea of paying themselves first. It is time to change that equation: cut down your cell phone expenses, clothes and shoes expenses, and put those payments into your emergency fund.

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If you are among the many investors who don’t have a ‘rainy day’ fund stashed away in case of emergencies, there’s no time like the present to start saving, You can start simply by taking the change out of your pocket at the end of each day and saving it in a jar. You could also eat at home instead of dining out, and ‘tip’ yourself by adding a few cedis to your emergency fund.

The Bottom Line

You need to view your emergency fund as an insurance policy; and once you have it created, guard it carefully. You should never dip into it for incidental expenses. Use it only in the event of an emergency, and hope that an emergency never happens. Remember, once that money is spent the time it takes to replace it is always much longer than anticipated. Start now and save whatever you can, even if it isn’t much. Some day, when you need the money and you will be glad you did.

ABOUT OMEGA CAPITAL

Omega Capital Limited is an Investment management, private equity and investment advisory firm. The company is authorised and regulated by the Securities and Exchange Commission of Ghana.

Analysts:

Nana Kumapremereh Nketiah (JP)

Sophia Obeng- Aboagye

 

Email: nana.nketiah@omegacapital.com.gh

Website: www.omegacapital.com.gh

Disclaimer

Additional information is available upon request. Information has been obtained from sources believed to be reliable but Omega Capital Limited (“Omega Capital” or “The Firm”) does not warrant its completeness, accuracy or veracity. The firm is licenced and regulated by the Securities and Exchange Commission of Ghana (SEC). This material is for information purposes only and it is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and estimates herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information.

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