Sunday, June 24, 2007

Building an Emergency Fund

How much should I save? As a rule of thumb, a saving ratio of 20% is considered healthy. Saving ratio is defined as total annual saving divide by total annual income.

As you start saving, your first priority is to build up your emergency fund. Establishing an emergency saving account is vital in both good and bad times. It is an absolute necessity for financial security because it gives you funds to fall back on if you or your spouse lose your job, incur large medical bills, unable to work for certain reasons, and so on. Without an emergency fund, you may be forced into incurring credit card debts that could take you many years to pay off. You don't want to be living on the edge, do you?

To build up your emergency fund, you have to put away the money consistently on a regular basis. As it grows, be sure not to dig into it for non-emergencies purpose. Remember, this fund can only be tapped for true emergencies.

How much do you need in this emergency fund? The minimum amount to have should be at least 3 to 6 months of your basic living expense. It has to be sufficient to tie you over during the period when your income stream is suddenly cut off. So examine carefully your income and needs to decide how much you actually should save. The level has to be comfortable to you.

Where should you be keeping your emergency fund? Emergency fund must be easily and quickly available and accessible when needed. It is best kept in liquid assets. Liquid assets refer to assets that can be converted into cash quickly. Example of such assets include saving account, time deposit, money market funds, and short term bonds. Do not put your emergency fund in property and stocks/shares. Property is not a liquid asset because it takes months to sell it. Stocks/shares are somewhat more liquid than real estate, however you can lose money if you are forced to sell it at the time when the market for your stock/share is less favorable.

No comments: