As we have all seen recently, things way beyond our remit can negatively affect our investments and therefore our lives as a whole. It doesn’t matter too much if you are taking a long term view of things, but these world changing events can have such an impact on what you do and how you live. Let’s have a look at the worst case scenario:
You lose your job.
Where will you get money for food and rent and your children’s education fees? You don’t want to dip into that investment portfolio.
After all, you’ve built it with a particular goal and time frame in mind. Touch it now and risk making your future dreams unattainable. That’s why it’s important to set aside money in an emergency fund before you begin investing. Here are some pointers for what your emergency fund should cover, how long it should last, and where to put it.
Don’t assume that any future unemployment insurance payments or redundancy pay can take the place of an emergency fund. Think of collecting either of these as a way to strengthen the safety net you’re constructing. It shouldn’t be your sole support. And if you do earn yourself a welcome redundancy package or collect unemployment insurance, your emergency fund will simply last longer. We recommend that you cover all conceivable expenses in your emergency fund.
These include food and shelter, mortgage or rent payments, entertainment (including eating out/takeaways). Pet bills, utility payments, phone, cable/satellite and internet. Transportation, taxies, school bus fees, fuel, maintenance, insurance. Health cover (no longer paid by your employer), home insurance, life insurance. Dental work, eye care and prescriptions.
That’s a long list to compile and come up with hard numbers for. The good news is that you don’t have to try to brainstorm every conceivable expense. Instead, track what you spend in the next few months and use that as your baseline. Then add in any other possible expenses, such as taxes or finding a job, that didn’t pop up during those months. If you spent money on movies or your gym membership, include that. If you’re out of work, taking in an occasional film and working out may help relieve some of your stress.
How long should it last? The general recommendation is setting aside up to six months of living expenses in an emergency fund. If your “emergency” ends up lasting longer than six months, or if you have taken a liberal view of living expenses, and pinching with the ideas that we’ve been talking about so far, your emergency kitty likely will last a little longer.
Paul McLardie is a partner at Total Wealth Management. Contact him at Paul.firstname.lastname@example.org