“A penny saved is a penny earned”
In the wealth creation journey, it’s critical to build an emergency fund. An emergency fund as the name suggests is money that you have set aside just in case you encounter unforeseen, urgent financial needs. This fund is essential because it bridges the gap between your pressing need and the availability of substantial amounts of money sometimes at no notice.
There is a lot of debate around how much should be kept in an emergency fund. I’m convinced that is important to have at least six months’ worth of expenses set aside for this purpose. If your income is seasonal or ad hoc then nine to twelve months will do.
How to build the emergency fund
1. Assess what your monthly expenses include.
Be sure to include loans and all other deductions that are usually make through check-off or standing orders, at least before you access your money.
There are expenses that tend to creep up on us, usually annual payments such as insurance payment and subscriptions. Include these as well for completeness of all your obligations, you can have them broken down monthly as well.
2 . Incorporate the savings for emergency fund in your budget
Please remember that this fund should be built over time and the sooner you put it in place the better for you. However only bite what you can chew. Include the amounts towards emergency fund as a monthly budget line item every month until you reach you target.
3. Look out for inflation
As you accumulate your money you will also need to be sensitive to decreasing purchasing power due to inflation. So you will need to place the funds in places where your money will march or even surpass the prevailing inflation rates.
Because of the nature of emergencies, it would be prudent to keep such funds in an easily accessible place. Most of the avenues available for such savings do not have high returns and this is ok because what is crucial for an emergency fund is capital preservation and not growth.
Where to place your emergency fund
Where should you put this money so that it is accessible but not too accessible? Good question, some of the products available in the market include savings accounts in Banks, SACCOs and Money Market funds.
It is also not uncommon to find some people using Fixed deposits and Treasury bills to accumulate their emergency funds. My take on these investment vehicles is please approach them with abundant caution, as the money kept in fixed deposit accounts or Treasury bills is not easily accessible and will suffer penalties if you cash in before the agreed period lapses.
Of the products I have mentioned, savings accounts will traditionally give the lowest return. The interest rates differ from bank to bank.
I wanted to find out what savings products and returns are available in the market, so I sampled some Tier 1 banks in Kenya and visited their websites. See the savings products available; Cooperative Bank; NCBA Bank; Equity Bank Standard Chartered Bank; DTB Africa and Absa Bank
What I like about the savings products is that the minimum required to start saving is between 1k – 5k which means you can start with what you have and grow it. However, most of the banks don’t give interest rates on their websites apart from. Ordinarily savings accounts give moderate to low interest rates, much less than Treasury Bill rates, however they are a very good avenue to develop the discipline of saving.
My personal favorite place to build as emergency fund is in a Money Market Fund. Some of my reasons include:
- It is highly their flexible; You can deposit and withdraw as many times as you want without restrictions.
- Low minimum amount requirement. Most funds have a minimum deposit requirement of Kshs 500 to Kshs. 1,000
- Withdrawal of cash can be done on short notice. Sometimes as short as 1 – 2 days.
- They give good returns, sometimes equal to or higher than Treasury Bill rates.
- They are regulated by Capital Markets Authority which issues licenses to the Funds as well as the Fund Managers.
- Money Market funds, invest in relatively Low risk avenues. This means my capital is preserved.
There are many investment firms providing money market funds products. Their interest rates are published in newspapers where their daily and annualized yields are reported.
Some funds report their interest rate as gross of withholding tax but net of management fees. This just means that they have deducted their percentage fees from the interest rate, but the interest earned is subject to a tax deduction. Most will however report their interest rates having taken care of both the management fees and taxes.
How to choose where to invest
I would advise that you do some research on the company you want to invest in. Is the management team solid and more importantly their investment and fund managers? how is their corporate governance culture? How does their track record look like?
All said and done, whichever avenue you choose, be intentional about doing your research.