Building up an emergency fund

An emergency fund is one of those high-priority investments that everyone must have in life, since it provides you with a financial buffer to cover short-term expenses when unexpected events happen. Especially when you have a family, it’s the responsible thing to do. Not having one leaves you vulnerable to paying exorbitant interest rates on a credit card or bank loan. The rule of thumb is to accumulate 3-6 months of your gross salary for emergencies, but how do you get there, and what do you do once you get there?

When building up an emergency fund, it makes sense to invest in an accessible option like a unit trust that prioritises both capital protection and liquidity. The M&G Money Market Fund, for example, allows you to accumulate your savings to reach your emergency fund goal while giving you attractive returns for low-risk investment growth , and you can access it at any time. Meanwhile, bank savings accounts offer exceptionally low interest rates that won’t beat inflation, and fixed deposit accounts must be kept in the bank for long periods of time, making them inaccessible for emergencies.  

What happens once you reach your goal?

If you’ve reached your goal of saving three months’ worth of salary, why not continue to contribute to it until you’ve saved six months’ worth of salary? Either way, once you’ve reached your goal, your emergency fund should be left alone continue to grow, until you really need it.

An option to consider at this point is to continue investing, but via a unit trust like the M&G Inflation Plus Fund, which aims to outperform CPI by 5% (before fees) over a rolling three-year period. You’ll be able to do this safely because, even though this multi-asset low-equity fund is somewhat riskier than a money market fund, it is well-diversified and classified as medium-risk. Also, your investment time horizon will have lengthened because you’ve reached your savings goal – you can now afford to take more risk while earning potentially higher returns The investment time horizon for the Inflation Plus Fund is three years. You’ll have become accustomed to investing regularly to reach a goal and after all, you need money for your future, not just future emergencies. Remember that you need to top up your emergency fund if you dip into it along the way.

Depending on your financial goals, you might be looking for another discretionary unit trust fund. We believe that a tax-free investment could be a good option. The sooner you start contributing to the tax-free investment limits of R36 000 per year and R500 000 in your lifetime (never exceeding these or you’ll face high taxes), the longer your money can benefit from compounding – and your returns will be tax-free. This makes for a great option for medium- to longer-term savings.

Another tax-saving option for the longer term is to top up your existing retirement contributions. Remember that each year, as an individual taxpayer, you can claim a deduction on your annual contributions to retirement funds of up to 27.5% of the greater of your remuneration or taxable income. This is capped at R350 000 annually, which means you can invest a sizeable portion of your savings into your retirement fund now, to benefit later with a reduced tax requirement when you retire. 

It’s important to have short-, medium- and long-term investments

To maintain a healthy financial life, you need all three – short-, medium- and long-term investments. Your short-term timeframe is covered if you have an emergency fund; your medium-term investments like The M&G Inflation Plus Fund may take more time to build and could go towards a deposit on a home, or to pay for your child’s education. Your long-term investment is for retirement, and typically takes decades to accumulate successfully.

Making provision for each of these goals at the same time is not always realistic or affordable. If you feel stuck as to where to focus or have limited money to invest, getting your emergency fund in order is a key step. From there, you can invest for longer-term goals without having to worry about a financial emergency preventing you from maintaining your budget or investing towards your future. Of course, if you can afford to build your emergency fund and longer-term savings at the same time, you should, to allow as much time as possible to grow your investments. As is true with so many things in life, the earlier you start something, the more time you have available for progress, and you may even reach your goal sooner rather than later.

Financial stability and ultimately, independence, are worthwhile to work towards, and it’s easier if short-term issues don’t trip you up. Having an emergency fund to help you handle short-term crises can help you to stay on course with your financial plan. Your medium-term investments will open options such as buying property and then you’ll reach your golden years and be able to retire successfully. While there will certainly be ups and downs along the way, it all starts with an emergency fund.

Click here to start investing with M&G online. Alternatively, contact your financial adviser or our Client Services Team on 0860 105 775 or email us at info@mandg.co.za.