FOOL'S EYE VIEW
In Case of Emergency - Save!

By Jane Mack (TMFJane)
August 17, 2001

With all this talk of an impending recession, let us pause for a moment to think about how we'd cope if we were suddenly faced with an unexpected financial crisis. The loss of a job, perhaps? A major repair bill for the boiler or the car? What about an unplanned pregnancy with the ensuing loss of income?

Do you have an Emergency Fund on which you could draw to tide you over a rough patch?

Although the Motley Fool often stresses the logic of getting out of debt, it's not often we touch on the importance of building up and maintaining an emergency fund (some people call it an "e-fund") as well. We've mentioned in the past that you should strive to have liquid funds of between three and six months' income so that, should the worst happen, you have the facility to coast for a while.

It sounds a lot of money and you might think you could survive with the use of a credit card if you really had to. But those bills will need to be paid off at some point and you could find yourself struggling for much longer than necessary – and paying through the nose for it too. By all means, have a line of credit as a last resort but, since foresight is better than hindsight, you'd be better off with an emergency fund to start with.

So how much would be enough for you?

It all depends on what sort of lifestyle you lead, the financial commitments you have and the extent to which you could tighten your belt if you had to. In my opinion, one should plan for the worst and hope for the best and that means thinking about what sort of "worst-case scenario" could have a potentially damaging effect on your long-term finances.

So, you should first look at your current essential monthly outgoings. There are certain things that really need to be paid such as the mortgage, council tax, utility bills and food. But you could probably do without the things you merely want such as satellite TV and your mobile phone for example. Once you've got a rough idea of how much you'd need each month to get by in a temporary crisis, then multiply it by at least three (or a higher number if you feel more comfortable with it) and you've got a target figure to aim for.

Of course, you may think you have insurance to cover calamities such as a job loss or a boiler repair. But the money you spend on income protection insurance possibly wouldn't be paid out until you'd been unemployed for six months anyway (check the terms), and we've always said that extended warranties are almost always a waste of money. The whole point of having an emergency fund is that you're insuring yourself sufficiently against particular emergencies, thus doing away with the need for certain types of insurance cover. And bear in mind that this outlay is yours forever so, if you never have to access it, you've still got a nice lump sum to call your very own.

The important thing is not to think of your emergency fund as "savings" – it's not. Your "savings" are for a long time in the future, whereas this pot of money is for a passing crisis. So, if your clapped-out old banger goes phut-phut one day on the motorway, then don't hesitate to dip into your emergency fund to fix it. That's what it's there for. You can work on building it up again afterwards once the crisis is over. It goes without saying that you should keep it in an instant access high-interest account.

So, if you haven't got one yet, get yourself an emergency fund and then start saving for the future.