Emergency Funds - What, Where and How much.

Based on a survey conducted by the Inter-American Development Bank in 2020 to test financial resilience during COVID-19, Barbados appears to have a relatively high financial literacy rate of 54%(1) almost as high as the United States and though this can be seen as a positive indicator it is worth noting that the US 2018 National Financial Capability Study reported that almost half (46%) of Americans have not set aside funds sufficient to cover expenses for three months in case of sickness, job loss, economic downturn, or other emergency.

Having an emergency fund is one of the first stages towards attaining financial independence. An emergency fund is not something nice to have, it is a need to have!

As they say, you should always save for a rainy. But what is considered a rainy dnd how much do we actually need to weather the storm?

Let's start off by defining the key term: What is an Emergency Fund?

An emergency fund is a reserve of easily accessible funds set aside to cover unexpected events without going into debt.

An emergency fund acts as a safety net to cover unexpected events such as job loss, medical bills, natural disasters or even major car problems.

Having an emergency fund can provide a sense of security of not having to worry about today or a few months for that matter. It buys you time to figure out your next move, relieving you of any unnecessary financial stresses.

So we've figured out what an emergency fund is and what it is used for, let's highlight what it is NOT.

An emergency fund is not:

• Funds set aside for retirement, purchasing a home or tuition fees for your children.

• A fund you can borrow from to cover day to day expenses with the hopes to replenishing 'later'.

• Funds to use for leisure - social events, travel etc. It doesn't matter how good that travel deal is right now.

• Funds to use for home renovations or to cover normal wear and tear (maintenance) for your car. FinLit Tip: these expenses should be in your budget.

• Funds to use for cosmetic or any kind of aesthetic surgery.

• And our personal favourite, funds to purchase that luxury item that you think you deserve because you've worked really hard.

Now, recall that key word from our definition - easily accessible. This gives us a clue as to where our emergency fund should be held.

Place your emergency fund in relatively safe and liquid asset; your emergency fund should not be in stocks or mutual funds.

Ideally, these will be a high yield interest savings account (yes we know interest rates are ridiculously low) but remember the most critical element here is readily available. If you need money for an emergency the last thing you want to do is complete paperwork or sit and wait for days to access your funds.

Recall from our definition we said without going into debt, this one here is often where people tend to get trapped. Though credit cards and overdrafts facilities are easily available, this money is borrowed money and will always come at a cost.

Going into debt to cover basic and unexpected expenses does way more harm than good.

Now to address the million dollar question, how much?

Your emergency fund should cover 3-6 months of your monthly expenses, this differs from person to person. Of course we like to scale up given, well given Caribbean time - hiring takes time, accessing unemployment benefits take time. These are current realities so it would be wise to add a buffer to factor in delays.

Your Emergency Fund should cover at least 6 months of your core monthly expenses.

Your core expenses are your necessities. e.g utilities, housing food etc.

A more aggressive approach (our preferred approach) would be to have enough to cover your current lifestyle for six months without any income.

These numbers all come from your budget. FinLit Tip - use an average of the last 3 months as some expenses fluctuate month to month.

Conservative Approach Example:

Utilities - $300

Rent - $800

Food - $400

Total monthly necessities - $1,500

Emergency Fund = Total monthly necessities x 6 months

= $1,500 x 6 = $9,000

Aggressive Approach Example:

Utilities - $300

Rent - $800

Food - $400

Entertainment - $150

Personal Care - $100

Other - $100

Total monthly expenses - $1,850

Emergency Fund = Total monthly expenses x 6 months

= $1,850 x 6 = $11,100

Always save for the unexpected. Having an emergency fund can make all the difference in understanding your capacity to weather a storm without going into debt or falling victim to undue financial stress.

So we've covered the what, the where and how much, it's time to move to ACTION.

Calculate how much your emergency fund should be to identify your targeted goal or perform a quick check to determine if what you have saved is enough.

A good target amount would be $10,000.

Start with a small amount such as $1,000 and work your way up to that targeted amount. Only after you have secured your emergency fund then you can look to invest the excess cash.

How much is your emergency fund? We'd love to hear it, comment below.

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Disclaimer: The information provided in this article are for educational purposes only, intended for analysing, learning and discussing general and generic information. This information is not to be taken as investment advice, please seek professional guidance before making any financial decisions.

(1) Rates determined using the responses provided for 3 topic areas only: interest rate, inflation and risk.

All values quoted are estimates and denominated in BBD.